DATE: Tuesday, October 28, 1997             TAG: 9710280268

SECTION: FRONT                   PAGE: A16  EDITION: FINAL 

SOURCE: WASHINGTON POST 

                                            LENGTH:   74 lines

[STOCK MARKET] QUESTIONS AND ANSWERS

Q. Why did stock prices tumble on Wall Street Monday?

A. Partly because stock prices got too high relative to the profits of the underlying companies, the size of the economy and the returns that investors were getting from less-risky investments, such as government bonds.

Q. But that's been true for months. Why is this happening now?

A. All it takes to burst a speculative bubble is a definitive bit of bad news, and we got that from Asia. Investors concluded that the Asian financial markets will mean slower economic growth in that region, and thus sales and profits for the American companies that do business over there could be lower. When all that became clear, it not only reduced what investors were willing to pay for shares of stocks in these global firms, it also shook the confidence investors had in other companies.

Q. How much further can we expect stocks to go down?

A. Nobody knows. Many analysts calculated that stocks were 15 percent overvalued and, so far, stocks have fallen nearly 12 percent from their peak. Beware, however: Markets usually overshoot on the way down just as they overshoot on the way up. It wouldn't be surprising if stock prices fell by 20 percent before recovering.

Q. So why was stock trading halted twice Monday?

A. After the 1987 stock market crash, government regulators decided it would be a good idea to give traders a ``time out'' or breather to reduce panic buying or selling on days when the market is unusually volatile. One step involves closing trading for 30 minutes after a 350-point drop; another is to halt activity for an hour after a 550-point drop. The second stoppage came so close to the end of the trading day, that the market closed for the day just after 3:30 p.m.

Q. Does that mean it's a good time to switch from stocks to bonds or money markets?

A. Not necessarily. Remember, you'll have to pay broker commissions to sell stocks and then to buy them again later. And if the price of your stocks is still higher than what you paid for it, you'll have to pay a capital gains tax on the profit, unless your money is in a tax-exempt retirement fund. There's also the problem of knowing when to get back into the market.

For all those reasons, investment advisers usually tell individuals to avoid panic buying or selling.

Or think of it this way: Despite an 1,100 point-drop in the Dow Jones industrial average since August, investors are no worse off than they were in May.

Q. Does what's happening on Wall Street have any impact on the rest of the economy - jobs, wages, profits, that sort of thing?

A. Actually, there are both positive and negative effects.

Q. What's the bad news?

A. When the value of their stocks decline, consumers tend to pull back on spending a bit - about $30 for every $1,000 drop in wealth. For the economy as a whole, that means that if stock prices fall 15 percent and don't recover, consumer spending will drop by $30 billion over the next 12 to 18 months. That would mean lower corporate profits, fewer new jobs and slow wage growth.

Q. And the good news?

A. As investors flee from stocks, many are putting their money into the much safer government bond market, where long-term interest rates are set. The effect has been to drive down rates on the 30-year Treasury bond from 6.7 percent in early September to 6.12 percent Monday. And lower rates tend to stimulate economic growth by encouraging new investment and reducing the interest costs consumers have to make on their debt.

Q. So are we in for a recession?

A. Probably not. Taking all the various factors into consideration - fewer exports, reduced consumer spending, lower interest rates - forecasters were saying Monday that the growth rate of the U.S. economy could slow by as much as three-quarters of a percentage point over the next year. But with the economy now expanding at the annual rate of more than 3 percent, that still leaves a growth rate of 2 percent to 2.5 percent, which is actually closer to the level most economists and Federal Reserve policymakers consider healthy. KEYWORDS: U.S. STOCK MARKET

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