Ordinarily, explanations for why the stock market behaved as it did on any given day are pointless attempts to pinpoint causes that do not exist. But today, there was a simple explanation for the 374-point drop in the Dow: Consumer-products giant Procter & Gamble warned that it would miss estimates for its third quarter and its current fiscal year, and that warning brought the rest of the Dow crashing down (albeit not as much as P&G itself, which dropped 31 percent).
The sell-off in P&G itself may have been something of an overreaction--the stock opened down 30 points, and actually rose a little from there through the day--but the company's morning conference call did suggest real trouble ahead for a lot of so-called Old Economy companies. P&G cited the impact of rising oil costs, higher commodity costs in general, and pricing competition abroad. In other words, it cited all of the factors that start to eat away at profits in a fast-growing, competitive economy (all of the factors but one, that is: rising labor costs). In the recent past, when companies such as P&G have issued profit warnings, Wall Street has tended to quarantine the problem, attributing it to poor management or company-specific concerns. But no one has any real doubts about the quality of P&G's management, and the problems seemed not company-specific but eminently generalizable.
The paradox here is that even though economic growth is good for consumer companies in general, since the more employed people there are the more people there are to buy Tide and Febreeze (as opposed to the supermarket brand), growth also brings with it the risk of rising prices, particularly commodity prices. And although P&G's competitors expressed complete certainty that they, unlike P&G, will be able to pass any rising prices along to consumers (which itself would be not the best news on the inflation front), it's hard to believe that consumer-products companies have much meaningful pricing power anymore. (To have pricing power means that you can charge more for your brand of toothpaste or detergent than your competitor does, either because of some real difference between the products or because of brand strength.) Quality has become, in some sense, diffused, which is a great thing from the point of view of consumers but a bad thing from the point of view of the brand-name giants. And if Procter & Gamble couldn't pass rising costs along, it's not obvious why Clorox or Colgate will be able to.
What the Street's reaction to the P&G news suggests is two things: Contrary to a lot of the "this is all tulip-mania hype," investors still care tremendously about profits. P&G, in fact, said explicitly in its conference call that it had imagined that if it worked on boosting revenue, then profits would increase as well. But that did not happen, and it was the fall-off in the bottom line that sent investors scurrying for the doors. The second thing about the reaction is that the risk-to-reward question has become very complicated on Wall Street. Traditionally, one of the reasons to own stocks like Procter & Gamble as opposed to New Economy high-fliers like, say, Exodus or Inktomi is that while P&G isn't going to jump 25 percent in a single day the way an Exodus might, it's also not going to fall 20 percent in 10 minutes, the way the New Economy stocks sometimes do. (Today, for example, Inktomi fell from $190 a share to $158 a share in what seemed like the blink of an eye.)
But that logic doesn't work so well when, in fact, blue-chip stocks can drop remarkably fast remarkably quickly. If there's significant risk to the downside, but nowhere near as much potential reward to the upside (as seems to be true with a company like Procter & Gamble or Gillette or even Coke), then why would it make sense to invest in these Old Economy companies? As it happens, there is a reason, which is that after a sell-off like the one P&G just went through, its risk to the downside is significantly smaller, while its upside potential is correspondingly greater. But that's only true after the stock gets crushed. Which makes for an odd picture of the current stock market: You've got bottom-feeders, picking up the beaten-down; momentum investors, pushing the high-fliers higher; and a lot of the people in the middle, who right now are perhaps wondering where the next P&G-style debacle is going to occur.