The stock market plunged almost 35 points in less than 30 minutes yesterday under an avalanche of sell orders cranked out by computers that run multimillion-dollar stock trading strategies tied to stock index futures.
The Dow Jones industrial average recovered slightly from the sudden burst of late selling to close with a 28.86 point loss for the day at 1,766.40.
Stocks worth an estimated $150 million were dumped on the market in the final hour of trading by large institutions, such as pension funds. One experienced market watcher estimated that six huge baskets of stocks, containing millions of shares, were sold between 3 p.m. and 4 p.m.
Computer-assisted trading has helped whipsaw the market on several recent occasions. On March 21, the Dow Jones industrial average fell 35.68 points. On Jan. 8, the market dived 39.10 points. Defenders of computer program trading contend that buying waves have helped send the market higher, too, as on March 11, when the programs helped the Dow rise 43.10 points.
The Securities and Exchange Commission and other market participants have expressed concern about the volatility caused by program trading.
Yesterday's sudden plunge in stock prices astonished even veteran stock traders who are usually prepared for the impact of trading programs.
"We were sitting here fat, dumb and happy, not doing much of anything before the programs hit," a trader at a New York brokerage firm told Dow Jones News Service. "Outside of the programs, it was very quiet."
The reaction from other market players was less sanguine. "The only ones who make money on these [programs] are the people who are arbitraging the indexes," said Ernie Rudnet, manager of block trading at Mabon Nugent & Co. "No one else has a chance to react."
In the game called "index arbitrage," buying and selling of stocks and futures contracts is governed by the gap between the price of a basket of stocks, as represented by a stock index, and the price of futures contracts on that same index.
When the price of the futures is significantly higher than the stocks, traders buy large amounts of stock and sell the futures contracts. When the price gap narrows, traders sell the stocks and buy back the futures contracts.
The price gap between stock and futures prices -- called the "spread" in trader parlance -- unexpectedly narrowed twice yesterday, encouraging traders to sell millions of dollars of stocks.
One of the most popular indexes used for program trading is the Standard & Poor's 500. Traders try to buy a group of S&P stocks that will mirror the performance of the index and then sell futures contracts on that index.
A trader gave this description of yesterday's action:
The S&P price spread had been narrowing during the early part of the day when, about 3 p.m., it suddenly tightened from about 1.40 points to .10 points, a perfect opportunity for selling stocks. With only a few minutes to act, brokerage houses sold two baskets of stocks, one worth $25 million, one worth more than $2 million.
Then, as suddenly as it collapsed, the price spread widened back to about 2.40 points, and "everything came to a halt," the trader said. At that point, individual traders, perhaps worried about market direction, began selling futures, and once again the price spread narrowed to about .10 point.
"The whole place came apart," the trader said. "Package after package was unwound."
The Dow Jones News Service reported that a rebound in oil prices and profit-taking in the bond market were cited by market watchers as reasons for the late weakness in the stock index futures slated to expire in June.
Meanwhile, bond prices also pulled back yesterday. The price of the bellwether 30-year Treasury bond tumbled about 1.25 points or $12.50 for each $1,000 in face amount. The yield moved up to 7.48 percent from 7.39 percent Wednesday.
Stocks that had benefited from the recent drop in oil prices appeared to be encountering selling pressure from investors concerned that the prices had bottomed out. The Associated Press reported that crude oil futures, which briefly edged below $10 a barrel earlier in the week, rose to $11.75.
Auto stocks were mostly lower in yesterday's trading as domestic car manufacturers posted sharply lower March sales figures. General Motors fell 2 3/4 to 80 1/4, and Ford Motor 1 5/8 to 81 1/8. Chrysler, however, edged up 1/8 to 43.
Tobacco issues fell in selling ascribed to concern about the scheduled trial next month of a new product-liability suit. Philip Morris dropped 4 1/2 to 110 1/4 and R. J. Reynolds Industries 1 3/8 to 39 1/4.
Other prominent losers among the blue chips included Merck, down 4 at 170 1/2; McDonald's, down 2 3/4 at 94 1/2; Minnesota Mining & Manufacturing, down 2 1/4 at 100; DuPont, down 1 1/2 at 73, and Eastman Kodak, down 1 1/2 at 60 1/8.
Such household names are commonly involved in program trading. At the same time, however, many smaller financial, utility and home-building stocks declined as investors watched oil prices and interest rates rebounding.
In the financial sector, for instance, Great Western Financial lost 1 5/8 to 41 3/4, and H. F. Ahmanson was down 1 1/8 at 64 3/8.
The daily tally on the Big Board showed more than two declining issues for every one that gained ground. Losing issues ran ahead of winners 1,170 to 531 among the 2,072 issues traded.