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FEELING SEASICK?
MARKET'S VOLATILITY COULD SIGNAL OVEREXTENSION

If you like to spend your summers riding the Viper at Darien Lake, you've probably been getting a kick out of the stock market this year.

After five straight years of relative calm on the stock market, share prices have been moving up and down this year like a roller coaster.

Consider this: During the last 52 years, the Standard & Poor's 500 index has risen or fallen by 1 percent or more about once every six trading days, or about 16 percent of the time. This year, the S&P 500 has had a 1 percent move about once every 3 1/2 trading days, or 29 percent of the time.

And the S&P 500 has gone up or down by 2 percent on 11 days so far this year. The S&P 500 moved that much in a single day only six times in the five years from 1992-96.

Yet this year, almost every day has been a wild ride for the stock market. Research by Elizabeth MacKay, an analyst at Bear Stearns & Co., found that the stock market, as measured by the S&P 500, has been more volatile on an intraday basis this year than it has been in at least 12 years.

So far this year, the S&P 500 has moved by at least 1 percent at some point during the trading day 70 percent of the time, which is almost double the 38 percent average from 1985-96, Ms. MacKay found.

But the stomach-churning volatility this year makes the market seem even more topsy-turvy because the last 5 1/2 years have been unusually quiet.

The S&P 500 moved by 1 percent or more on an intraday basis during only 15 percent of the trading days in 1993 and 17 percent in 1995. You have to go back to 1991, when half the trading days had intraday volatility of 1 percent or more, to find a year that had such an unusual number of significant swings.

"We view this as more of a return to normalcy," says Christopher C. O'Donnell, a portfolio manager and research analyst at Elias Asset Management, a Williamsville money management firm. "In the 1990s, it was more notable because of the lack of volatility."

But unlike 1987 and 1990, which were the last two years where intraday volatility topped 1 percent more than 60 percent of the time, the unusual ups and downs are taking place when the market is on a record-setting pace and up 30.3 percent for the year. In contrast, the S&P 500 had a total return of just 5 percent in 1987 and lost 3 percent in 1990.

Just why the market has become more volatile this year is a matter of some debate.

Francis G. Leonard, president of Courier Capital Corp., a Buffalo money management firm, says the historically high valuations that stocks now command is a big factor behind the volatility.

Leonard thinks the stock market is getting overextended, especially among the nation's largest stocks. That makes stocks particularly vulnerable to bad news, such as disappointing earnings or slower-than-expected growth. When that happens, those stocks have tended to fall sharply.

"When you are extended, you normally get more volatility," he says. "I think people are gradually beginning to realize that earnings can't grow in line with expectations (of about 10 percent) in an economy that is growing at 2 or 3 percent" and key overseas markets, especially in the Far East, in rough shape.

Leonard also thinks some investors are getting nervous about the unusual balancing act by the economy, which has kept inflation in check and interest rates rather low, despite unusually low unemployment and factory production running at historically high rates.

While traditionalists worry that low unemployment and high capacity utilization rates typically have helped trigger inflation and higher interest rates in the past, there's a growing school of thought that says this time, things are different.

Those who believe in a new economic era think the growth of computer technology has fostered a new era that allows modest growth without sparking inflation, higher interest rates or rising unemployment.

"There are conflicting views out there on the economy," O'Donnell says. And that split could be contributing to the volatility, he says.

"You get doubts coming in, then reassurance, then more doubts," Leonard says.

O'Donnell also says the recent rule changes that narrowed the price spreads on stocks from eighths to sixteenths could be adding to the volatility by encouraging more computerized program trading. By quoting prices in sixteenths, O'Donnell says arbitrageurs, who try to profit from the minute differences in the prices of the same stock in different markets, now can take positions in stocks that have spreads of as little as one-eighth of a point.

Still, investors probably are better off by trying to ride out the volatility and sticking to good quality, less speculative stocks, says Diane A. Bishop, vice president and research director at Robshaw & Cheskin Associates Inc., an Amherst money management firm.

"Whenever I see the market behaving in a way that makes me nervous, I'm comforted by the companies with strong balance sheets," she says.

O'Donnell agrees, advocating big, well established companies, such as General Electric, Exxon, American Express and Boeing, which have long histories of profits and also have been through the ups and downs of both the stock market and the economy.

"Maintain your discipline," O'Donnell says. "You will do more harm by reacting to the volatility. Over a period of time, things tend to smooth themselves out."

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