Coping When the Market Turns Ugly

In the punch-drunk stock market, the hits just keep on coming.

On Tuesday, Dow Chemical reported quarterly earnings down 50% from a year ago. The stock plunged 10%, off $5.75 to $52.375.

Cap Cities/ABC lost $55.50 to $533, a 9% loss, after projecting a weak third quarter.

Morgan Stanley, the investment banking firm, tumbled 8%, down $6 to $66.50, after reporting earnings off 49%.

The Dow Jones industrial average managed a 17.82-point gain on Tuesday, to 2,922.52, calming some fears of a mini-meltdown after Monday’s 56.44-point loss. But most of the Dow’s gain stemmed from a surge in oil stocks, on fears of Mideast troubles. Outside of the Dow, the broad market continued to be weak on Tuesday, and small stocks in particular were hard hit.

For pension funds and other big investors, this is a take-no-prisoners market where anything can happen, and probably will. Those investors are mercilessly beating up shares of any company that had the gall to earn less than what Wall Street expected in the second quarter.

For individual investors, the market has suddenly become the same ugly place they remember from last January, last October and other recent periods when stocks plunged without warning.

The problem is that not many people are remembering what happened after those ugly periods. That is, the market recovered and moved higher. Not all stocks did, of course. But you only need to randomly check the 52-week highs and lows in the stock columns to see just how low some stocks sold last year, compared to where they are now.

As simplistic as it may sound, many veteran investors say there’s only one course of action for individual investors in a market like this. You review what you own and why you own it. If your outlook has changed, then you act. If your outlook hasn’t changed, you shouldn’t allow Wall Street’s crazy, short-term mood swings to bother you.

Norman Fosback, a long-time bull who writes Market Logic and other market newsletters from Ft. Lauderdale, Fla., notes that many investors still aren’t used to the “new math” of market indexes such as the Dow. A 100-point swing sounds like a big deal, Fosback says, because it would have been major damage in the 1970s and most of the 1980s, when the Dow ranged from 700 to 1,300.

A 100-point drop at Dow 1,300 would have been a 7.7% loss. But at 2,900, a 100-point drop is a 3.4% loss. That’s $1.70 off a $50 stock. “We have to change our thinking,” Fosback says.

He believes that the market is overdue to retrench a bit. Many companies’ disappointing earnings suggest that the economy is weaker than expected. The strained financial system could be hit by more shocks. And the direction of interest rates is as uncertain as ever.

What’s more, it’s a simple fact that a lot of money has been made, on paper, in many stocks this year. Traders and long-term investors alike will naturally be inclined to sell some of those winners, whether it’s Coca-Cola or Waste Management or Eli Lilly. Taking a profit isn’t such an odd idea, after all.

Historically, a “correction” has clipped 10% to 15% from the market. A 15% loss would take the Dow from 2,922 to 2,484, a drop of 438 points.

So why not sell everything now and get back in when the market bottoms? “The problem is knowing when to get back in,” Fosback notes. “That’s a tough thing to call.” What’s more, you’d owe taxes on any gain, and you’ll pay a commission to sell and another commission to get back in.

If you bought a stock earlier this year because you liked its two- or three-year potential, a drop of 10% to 15% in the price shouldn’t change your mind about it, unless the company’s longer-term business outlook has been severely altered.

Of course, some stocks are being treated as if their long-term potential has in fact been altered. Dow Chemical now is down 31% from its 52-week high of $75.75. If you bought Dow at its peak, you may find it tough to believe that you’ll recoup your losses any time soon.

But unless the economy is headed for a full-fledged recession, the market’s current turbulence will run its course before long. And if the economy picks up in 1991, it’s easy to see a lot of beaten-down stocks picking up again too. The latest market ugliness won’t last. And the minute stocks turn, this period too will be forgotten.

Don’t get the bulls wrong: They aren’t saying that every stock will eventually recover its old highs and set new ones. Sometimes, you have to admit a mistake and move on. It all comes down to your belief in the company.

The key is sticking with your discipline. “People who are in and out of the market miss the whole point,” says Tom Green, who runs brokerage Thomas Green/San Diego Securities in Los Angeles. A 30-year market veteran, Green says the only way he can pick stocks for clients is from a long-term perspective.

“Program trading is a bother and a concern,” Green says, “but in buying a stock, I’m buying a company, and I’m buying a business. You have to think long term--that’s why the market exists.”

Biotech’s Continuing Allure: One myth about the market’s decline over recent days is that investors have dealt the worst blows to the growth stocks they snapped up so hungrily in the spring.

In fact, growth stocks aren’t being dumped indiscriminately. If a company reports poor earnings, it’s trashed. But those that have delivered on earnings are holding up fine. Philip Morris lost $1.125 in Monday’s tumble, then rebounded 62.5 cents to $49.625 on Tuesday. Liz Claiborne lost 75 cents on Monday, then jumped $2 to $32.50 on Tuesday. Does that sound like indiscriminate selling?

Perhaps the best symbol of investors’ underlying optimism about growth is the biotech industry. Most of those stocks have doubled or tripled from their 1989 lows. They’ve dropped back a bit recently, but remain high on many investors’ “buy” lists.

The irony of the appetite for biotech stocks is that most of the companies are still losing money. So they’re growth stocks in the most optimistic sense of the term--the expectation that they’ll finally grow into some black ink. Considering the sudden skittishness about earnings, it’s perhaps surprising that more investors haven’t bailed out of biotech stocks.

Robert Kupor, analyst at Kidder, Peabody & Co. in New York, says investors are content with biotech because the proof of the industry’s potential has begun to show. Leading companies such as Amgen Inc., the Thousand Oaks-based firm, and Cambridge, Mass.-based Biogen Inc. are solidly in the black this year, after years of losses or marginal results.

“There’s a sense that this group, considered a lost cause just a year and a half ago, has finally come of age,” Kupor said.

Many of the companies have been developing their first drugs for the past seven years, Kupor notes. “Now, we’ve come to that magic moment where the (government) has given or is about to give approval for those drugs,” he said.

The force behind Amgen’s stock, which has soared to $87.50 from $37.50 over the past year, has been its drug Epogen. That wonder drug stimulates red blood cell production in humans, which is crucial in the treatment of kidney failure. The drug has been on the market only since last year, but it is so successful that Amgen’s revenue rocketed to $72 million in the quarter ended June 30, versus $28.5 million a year earlier.

Amgen is expected to earn about $1.88 a share in calendar 1990, up from 19 cents in calendar 1989.

That kind of growth potential has driven investors to snap up other biotech stocks as well, in anticipation of blockbuster drugs. Indeed, Steven Gerber, analyst at Bateman Eichler, Hill Richards in Los Angeles, notes that three biotech companies--Cetus, Immunex and Biogen--face a big day next Monday, when the Food and Drug Administration is scheduled to announce actions on drug applications that the three have pending.

But Gerber warns that, despite the euphoria in biotech now, there are plenty of risks. One is the pricing issue: Will the government ultimately force biotech companies to lower the price of their wonder drugs to make them available to more potential users? That issue is unlikely to go away and, if anything, will become more heated soon.

Another risk is competition within the industry. Amgen is fighting in court to keep rival Genetics Institute from introducing its own version of Epogen, which could crimp Amgen’s sales.

Finally, there’s the simple question of valuation. How high should the stocks go, relative to the earnings they might have in 1991?

Many analysts caution that the rally over the past year has put biotech stocks at levels that make them suitable buys only for investors who can tolerate extreme risk.

Even so, Gerber says, Wall Street’s love of biotech is unlikely to dissipate soon, unless the FDA drops a bomb on Monday and delays action on the new drug applications.

“This is one industry where the United States hasn’t rolled over in its (leading) position in the world,” Gerber notes. “People can still feel good about biotech,” and that’s an important plus for the stocks.

BIOTECH: STILL HOT

Investors may be dumping many growth stocks, but they still like the biotech group--even though most of these firms still aren’t making money. Many biotech stocks rebounded Tuesday, while small stocks in general continued to sink.

52-week Tues. close Est. ’90 Stock high/low and change EPS* ALZA $49 3/8-$27 3/4 $44 3/8, - 3/8 $0.80 Amgen 87 7/8-37 1/2 87 1/2, +2 1.88 Biogen 26 1/2-11 5/8 24 1/8, + 5/8 0.05 Calif. Biotech 11 5/8-5 1/2 10 1/8, + 1/4 -0.58 Centocor 45 3/4-16 1/2 40 , -1 1/4 -0.25 Cetus 22 1/2-13 5/8 17 1/4, + 1/8 -1.51 Cytogen 12-4 7/8 10 1/4, + 1/8 -1.00 Genetics Instit. 43 1/2-24 1/4 36 1/2, + 1/4 -1.43 Immunex 36-12 5/8 32 1/4, + 7/8 -0.60 XOMA 26 1/2-16 1/2 24 3/4, + 1/4 -1.00

Source: 1990 EPS (earnings per share) estimates from Prudential-Bache, figured on calendar basis