Beware If Bears Are Dressing Like Lambs

Bear markets sometimes arrive wearing a little lamb’s outfit. And by the time the wool comes off, it’s too late for most investors to escape.

The idea that the bear has already arrived on Wall Street--but in disguise--is gaining popularity as analysts struggle to explain why the stock market has superficially reacted so little to the economy’s latest slump.

Despite news Friday that the nation lost 241,000 jobs in November--far more than even the biggest pessimists had expected--most major stock indexes actually rose for the day. The New York Stock Exchange composite index, for example, gained 0.78 points to 209.74 and now is just 4.4% below its all-time high reached earlier in the fall.

The market’s relative calm belies the apparent panic in the White House and at the Federal Reserve over the sinking economy. After Friday’s employment report, the Fed again cut market interest rates in a desperate attempt to get consumers and businesses spending:

- The rate on three-month Treasury bills fell to 4.24% on Friday from 4.34% on Thursday. The T-bill rate now is the lowest since the summer of 1972.

- Lower T-bill yields have in turn pulled down yields on bank CDs, lowering banks’ cost of money and thus allowing them to cut loan rates. On Friday, the average fixed-rate mortgage cost 8.62%, the lowest since April, 1974.

Classic bull-market thinking that has ruled Wall Street all year dictates that lower interest rates are always good for stocks. Each drop in rates means CDs and bonds dim as alternatives to stocks. Meanwhile, if lower rates spur borrowing and spending, that should eventually lift the economy and corporate profits.

That’s why, say the bulls, the market hasn’t crumbled--the surprise 120-point Dow Jones plunge on Nov. 15 notwithstanding.

The market still hopes for the best, even as the economy weakens.

But some experts now argue that Wall Street’s outward optimism about the economy, as measured by the NYSE index and other broad market gauges, has in fact been a ruse. Those indexes have declined relatively little from their 1991 peaks only because a few big stocks--such as retailers Home Depot and Wal-Mart--have continued to soar, pumping-up the numbers.

To look deeper into the market is to see a frightful sight, says Merrill Lynch & Co. analyst Richard McCabe in New York:

* A Merrill screening of 5,500 stocks shows that 62% tumbled in September, October or November to prices that were at least 20% below their peaks in the first eight months of the year.

* Within the same group of stocks, 48% were off 30% or more from their earlier 1991 peaks.

So while the broad market indexes are down only about 5% from their 1991 highs, nearly two-thirds of all stocks have already fallen 20% or more. That figure is key, because the traditional definition of a bear market is a market decline of at least 20%.

Is this a bear market in disguise? “That’s basically what the numbers imply,” McCabe says. “An awful lot of stocks are deteriorating by an awful large amount.”

The pessimistic scenario now goes like this: Short-term interest rates just keep dropping, but it doesn’t help the economy because consumers either A) can’t afford to spend money even with lower interest rates or B) don’t have any pressing need to spend money, because they bought nearly everything they need in the consumption-crazy 1980s, and then some.

So, say the bears, the economy will slide back into recession in 1992, knocking the bottom out of corporate profits and culminating in a deep market decline when investors give up even on their few remaining favorite stocks.

That’s pretty much how McCabe sees it. Wall Street may keep an optimistic face into January, he says, but without strong signs of an economic recovery he predicts a winter market plunge that will slice 15% or more from the Dow index. Measured from the Dow’s peak of 3,077.15 on Oct. 18, a 15% drop would pull the index down to about 2,600, versus 2,886.40 on Friday.

Of course, some stocks have already suffered worse, as noted earlier. And more stocks could be crushed mercilessly in the months ahead if the economy sinks faster than even the bears expect.

Money manager Morgan White, of Woodside Asset Management in Menlo Park, worries that “what you’ve got now is a form of depression that we just don’t recognize as such, because of all the safety nets in the economy”--as represented largely by the ballooning federal budget deficit.

Then why doesn’t White sell all his stocks and buy canned goods and shotguns? Because no matter how weak the economy gets, “there will be companies able to earn money and do well,” he says simply.

Tom Cashman, manager of the $1-billion MFS Growth stock mutual fund in Boston, agrees. The cruel reality of a recession, he adds, is that “the strong, well-positioned companies are just gaining more of an advantage over weaker competitors as each day goes on.”

For the average investor, that’s advice worth remembering before you do something rash, such as sell all of your stocks.

But given the unknowns about the economy, it would also be rash to go crazy and put too much into stocks right now.

If ever there was a time to be a sober, reasoned investor, this is it.