Stock Market

STOCK MARKET

STOCK MARKET. Originating in the Netherlands and Great Britain during the seventeenth century, stock exchanges initially enabled investors to buy and sell shares of companies to raise money for overseas expansion. Called "bourses," these exchanges eventually began dealing in the public securities of banks, insurance companies, and manufacturing firms. Until World War I, the London Stock Exchange was the largest and busiest in the world. Although inaugurated in 1792, when twenty-four New York merchants signed the Buttonwood Agreement, and formally organized in 1817, the New York Stock Exchange (NYSE), which is located on Wall Street in New York City, was small by comparison to the European bourses, with an average of only 100 shares traded per session. The NYSE attained preeminence only after World War I, which had disrupted the financial markets of Europe and transformed the United States into an economic power of the first order.

The Stock Market Crash

Flourishing throughout the 1920s, the stock market crashed on 29 October 1929, bringing to an end the era of economic prosperity and ushering in a new, impoverished age that few understood. Yet the stock market crash did not cause the Great Depression of the 1930s. Rather, the crash was one of the more dramatic symptoms of structural weaknesses in the national and international economies. Between February 1928 and September 1929 prices on the New York Stock Exchange steadily rose. For eighteen months, investors enjoyed a "Bull" market in which almost everyone made money. The cumulative value of stocks in 1929 reached an estimated $67.5 billion, with 1 billion shares traded. The price of stock, however, had long ceased to bear any relation to the earning power of the corporations issuing it. The ratio of corporate earnings to the market price of stocks climbed to 16 to 1; a 10 to 1 ratio was the standard. In the autumn of 1929, the stock market began to fall apart.

On 19 October 1929, stock prices dropped sharply, unnerving Wall Street financiers, brokers, and investors. Big bankers tried to avert a crash by conspicuously buying stock in an attempt to restore public confidence. Ten days later, on "Black Tuesday," all efforts to save the market failed. By 13 November, the crash had wiped out $30 billion in stock value. Most knowledgeable Americans, including Herbert Hoover who had been elected president in November 1929, viewed the crash as a necessary and healthy adjustment provoked by inflated stock and undisciplined speculation. Only paper empires had toppled, Americans reassured themselves. The crash, though, brought down the economies of a number of European countries. The American economy followed. The Great Depression had begun.

What Went Wrong

By 1928 the value of such stocks as the Radio Corporation of America, Radio-Keith-Orpheum (RKO), Westinghouse, United Aircraft, and Southern Securities were grossly inflated, exceeding any reasonable expectation of future earnings. Brokers, however, encouraged speculation in these and other stocks by permitting investors to buy shares on "margin," that is, on credit. Investors paid as little as 25 percent of the purchase price out of their own capital reserves, borrowing the remainder from brokerages or banks and using the stock they were about to buy as collateral. The abrupt decline in stock prices triggered panic selling and forced brokers to issue a "margin call," which required all who had borrowed from them to repay their debts in full. Many had to liquidate their remaining stock to meet their financial obligations, thereby precipitating the crash.

Remedying Abuses

Investigations conducted during the 1930s by the Senate Banking and Currency Committee, under the direction of chief counsel Ferdinand Pecora, uncovered ample evidence of fraud, corruption, misrepresentation, and other unsavory practices in an essentially unregulated stock exchange. To remedy these abuses, Congress passed the Securities Act of 1933 and the Securities and Exchange Act of 1934, initiating federal regulation of the stock market. The Securities Act required all companies issuing stock to inform the Federal Trade Commission of their financial condition. Complaints that the new law was too intrusive prompted Congress to revise it. The resulting Securities and Exchange Act established the Securities and Exchange Commission (SEC) and granted it extensive authority to monitor stock exchanges, brokerage houses, and independent dealers. The SEC gained additional regulatory powers through the Public Utilities Holding Company Act of 1935, the Investment Companies Act of 1940, and the Investments Advisers Act of 1940, symbolizing the intention of government to intervene more fully than ever before into the economic life of the nation.

The American Stock Exchange

Located only blocks from the New York Stock Exchange, the American Stock Exchange (AMEX), which was founded during the 1790s, is the stock market for small companies and small investors. The stock issues of organizations that do not meet the listing and size requirements of the NYSE are commonly traded on the AMEX. Once known as the "New York Curb Exchange" because dealers traded on the street outside brokerage houses in the New York financial district, the AMEX moved indoors in 1921.

Trading on the AMEX reached new heights as the 1990s drew to a close. Average daily trading volume was a record 29 million shares in 1998, up from the previous high of 24.4 million set only a few years earlier. More than 7.3 billion shares changed hands on the AMEX in 1998, up from 6.1 billion a year earlier. By 2000, the number of shares traded on the AMEX had reached 13.318 billion. On the NYSE, by contrast, 307.5 billion shares valued at $10.5 trillion changed hands in 2001, an increase of 17 percent over the 262.5 billion shares traded in 2000.

The National Association of Securities Dealers

In addition to organized exchanges, where brokers and dealers quoted prices on shares of stock, an Over-The-Counter (OTC) market had existed since the 1870s. Congress exerted control over the OTC market with passage of the Maloney Act of 1937, which created the National Association of Securities Dealers (NASD). Since its inception, the NASD has traded the shares of companies not large enough to be included on the New York Stock Exchange, the American Stock Exchange, or one of the other regional exchanges. In 1971 the NASD developed the National Association of Securities Dealers Automated Quotations (NASDAQ), becoming the first exchange to use computers to conduct business.

The volume of shares traded made the NASDAQ the largest stock exchange in the world at the end of the 1990s, with a record 202 billion shares changing hands in 1998 alone. Yet, the market value of the NASDAQ, a mere $2.6 trillion in 1998, paled by comparison to the market value of the NYSE, which totaled a staggering $10.9 trillion.

The Dow Jones Industrial Average

The principal index for assessing the performance of the stock market, the Dow Jones Industrial Average, dates from 1893 and at present includes thirty NYSE blue-chip stocks chosen by the editors of the Wall Street Journal. The blue-chips are comparatively safe investments with a low yield and a high price per share, but are issued by companies with a long history of good management and steady profits. Included among the blue-chips are the Aluminum Company of America (Alcoa), American Express, AT&T, Coca-Cola, Eastman Kodak, General Electric, General Motors, IBM, McDonald's, Philip Morris, Proctor and Gamble, Wal-Mart, and Walt Disney.

Bulls and Bears

Until the early 1980s, market analysts heralded the arrival of a "Bull" market when the Dow Jones Industrial Average reached 1,000 points. In a "Bull" market, the price per share rises and investors buy now intending to resale later at a handsome profit. A "Bear" market, by contrast, produces lower share prices; investors sell stocks or bonds intending to repurchase them later at a lower price. The Dow surpassed the 1,000 mark for the first time in 1972. A decade later it reached the unprecedented 2,000 mark before crashing on "Black Monday," 19 October 1987, when it plummeted more than 500 points in a single day and lost 22 percent of its value.

Riding the Bull: The Stock Market in the 1990s

During the 1990s the performance of the stock market was erratic. On 17 April 1991, the Dow Jones Industrial Average closed above 3,000 points for the first time in history. By 1995 the Dow had gained 33.5 percent in value and passed the 4,000 mark. In 1997 the Dow reached a high of 8,000, but began to fluctuate more wildly and unpredictably. In late October 1997, for instance, the stock market came as close to crashing as it had in a decade, when the Dow fell a record 554 points in a single day, equaling 7.2 percent of its total value, only to re-bound with a record 337-point rise the following day. At the end of the week, the market had ebbed and flowed its way to a mark of 7,442.08, the loss of a mere 4 percent in value.

Even when the Dow fell, the value of stocks remained far greater than it had been at the beginning of the decade. By 1998 the Dow had reached 9,000; it closed the century near 11,000 with no apparent limits on its ascent. But analysts could not predict how the market would perform over the short or the long term. Although the market continued to rise steadily, and at times dramatically after 1997, by the end of the decade many experts feared that its volatility suggested the bottom could drop out at any moment.

The Growth of the Stock Market

The unparalleled rise in stock values attracted hundreds of thousands of new investors. By 1997 more than 42 percent of all American families owned stock either directly or through pension plans and mutual funds. Easier access to stock trading through Internet brokerages, which enabled investors to trade stocks without a broker for commissions as low as $5 per trade, added significantly to the numbers of those who ventured into the market. By 1999 more than 6.3 million households in the United States had on-line trading accounts, with assets totaling $400 billion. The popularity of on-line trading encouraged people to conduct more transactions, and to buy and sell more quickly in order to take advantage of short-term changes in the market.

During the 1990s the percentage of wealth invested in the stock market grew at an alarming rate. As recently as 1990, Americans had entrusted only 16 percent of their wealth to the stock market. Even during the "Bull" market of the 1980s, the portion of income devoted to securities never exceeded 19 percent. At the end of the twentieth century, by contrast, stock investments composed a record 34 percent of Americans' aggregate wealth, amounting to more than the value of their homes. A prolonged decline in stocks would thus prove cataclysmic for the millions who relied on the market to ensure their financial welfare now and in the future.

Permanent Prosperity?

Market analysts, nevertheless, remained optimistic. Many looked forward to an endlessly prosperous future, believing that the American economy had undergone a fundamental structural change. The advent of information technology, the global market, and world peace promised to generate unprecedented corporate earnings and continually rising stock prices. Those who shared this perspective postulated a "long boom" that would carry the American economy past all the difficulties and limitations that had hampered it in the past.

By the end of 2000, however, a series of government reports disclosed surprising weaknesses in the economy, giving rise to speculation that the eight-year period of uninterrupted growth was about to come to an end. In response to rumors of a general economic slowdown, the stock market fell. By 21 December 2000, the NASDAQ Index, dominated by high-tech stocks, had lost nearly half of its value, declining to 2,332.78. The Dow Jones Industrial Average held steadier, closing above 10,600 points, but by the end of the year optimism on Wall Street had evaporated amid apprehension over corporate earnings that were lower than expected. Stock prices tumbled, losing approximately $1 trillion in just a few months. Throughout 2001 and 2002, especially after the terrorist attacks of 11 September 2001, economists were concerned that the continued decline in stock values would trigger a reduction in capital investment and consumer spending, the two forces that had sustained the economic boom of the 1990s.

In the wake of corporate scandals and the resultant loss of public confidence, the stock market plummeted during the second quarter of 2002. After reaching its peak in January 2000, the Dow lost 34 percent of its value over the next two-and-one-half years. During the same period, the NASDAQ composite plunged 75 percent, the worst decline for a major index since the Great Depression. The market subsequently rallied, but few analysts were willing to predict what would happen next during one of the most volatile periods in the history of the market.

BIBLIOGRAPHY

Friedman, Milton, and Anna J. Schwartz. The Great Contraction, 1929–1933. Princeton, N.J.: Princeton University Press, 1965.

Galbraith, John Kenneth. The Great Crash. Reprint ed. Boston: Mariner Books, 1997.

Geisst, Charles R. Wall Street: A History. New York: Oxford University Press, 1999.

Longman, Philip J. "Is Prosperity Permanent?" U.S. News & World Report 123 (November 10, 1997): 36–39.

Parrish, Michael E. Securities Regulation and the New Deal. New Haven, Conn.: Yale University Press, 1970.

Seligman, Joel. The Transformation of Wall Street: A History of the Securities and Exchange Commission and Modern Corporate Finance. Rev. ed. Boston: Northeastern University Press, 1995.

Sobel, Robert. AMEX: A History of the American Stock Exchange. Frederick, Md.: The Beard Group, 2000.

———. The Big Board: A History of the New York Stock Exchange. Frederick, Md.: The Beard Group, 2000.

White, Eugene N. "The Stock Market Boom and Crash Revisited." Journal of Economic Perspectives (Spring 1990): 67–83.

Mark G. Malvasi

See also Wall Street .