Long-Awaited ‘Correction’ Has Begun, Pros Say
The stock market is weak and getting weaker. So is this a great time to buy--or a chance to cash out before a much bigger decline sweeps Wall Street?
Many investors are facing that question now, after last week’s broad slide in stocks bolstered fears that something is seriously amiss in the market.
At the very least, this could be the start of the long-awaited “correction”--the gentle-sounding term for a sharp stock market pullback, usually on the order of 5% to 10% in market indexes such as the Standard & Poor’s 500.
At worst, some Wall Street veterans fear we’re on the verge of a genuine bear market, which would mean a 20% or greater decline in the S&P; 500, and much steeper drops in many individual stocks.
Admittedly, it seems absurd to worry about a bear market at a time when the economy and corporate profits are getting better. Though interest rates are inching up with the improving economy, the stock market has historically been able to overcome its fear of higher rates in the early phase of an economic pickup--so long as corporate profits are robust.
Stephen Poling, strategist at the Fortis Advisers fund group in St. Paul, Minn., said there was no talk of a bear scare at his shop last week. “Most of the talk here is about what a great opportunity this is for us to buy (stocks),” he said.
Even a simple 10% correction in the broad market is unlikely here, Poling argues. “It’s just too widely anticipated,” he said.
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Indeed, that has been the story for more than three years. Corrections are supposed to be regular occurrences in bull markets, as investors periodically take profits, temporarily driving stocks down to levels that lure new buyers.
But in the current bull run, now 37 months old, the market overall has yet to suffer a typical correction, even though investors have been constantly looking for one. While individual stocks have plunged from time to time, enough money has continued to flow into the market to keep it moving up.
Result: A steady three-year advance in indexes like the S&P; 500.
Last week, however, many Wall Street pros sensed an ominous change in the market’s tone. The shift wasn’t apparent in the Dow Jones industrial average, which hit an all-time high of 3,710.77 on Tuesday and closed the week just slightly lower, at 3,694.01.
But outside the narrow Dow, the bull market’s health is clearly deteriorating, many pros say:
* The Russell 2000 index of smaller stocks sank 2.7% for the week, and is now down 3.5% from its all-time high, reached Oct. 18.
Smaller stocks had led the market since midsummer, but investor interest has cooled markedly in these issues. Worse, some of the highest-flying small growth stocks of 1993 have been in deep selloffs since late October, and the pace of the selling accelerated last week.
* The market’s breadth--the number of stocks rising each day versus the number declining--turned sharply negative last week. On Nasdaq, losers topped winners for five days straight by a 3-to-2 margin. The same margin prevailed on the New York Stock Exchange every day but Tuesday.
* Other “technical” measures of stocks’ health also are flashing red. Richard Arms, a veteran market technician in Albuquerque, N.M., said his oft-quoted Arms index indicates that the market is “the most overbought it has been in almost a year.”
The Arms index relates the count of rising and falling stocks to the level of trading volume in each of those two groups. It’s a way of measuring the buying power behind the winners and the selling power pushing down the losers.
An overbought market is one in which so many stocks have advanced, on such heavy volume, that buyers’ firepower is believed to be exhausted. Any hint of bad news then can spark a plunge in prices, because there are so few able buyers left to step up and intercept tumbling stocks.
Wary analysts point to the almost relentless drop in utility and bank stocks since August as a sure sign that the market is short of buyers. The Dow utility index has plunged 12.8% from its Aug. 31 all-time high. As a result, the annualized dividend yields on many utility stocks are 7% or greater--yet investors seem in no hurry to snap up those stocks.
If the broad market is just now catching the utilities’ illness, it’s easy to project at least a 10% slide in prices, and maybe more, cautious Wall Streeters say.
The trigger could be a further sharp jump in interest rates. Last week, yields on 30-year Treasury bonds soared from 6.15% to 6.33%, highest since mid-August, on new signs of economic strength.
Richard McCabe, manager of market analysis at Merrill Lynch & Co., said many stocks should eventually overcome this initial rise in rates and push higher based on earnings expectations.
But historically, “for the market to make (this) shift without a disruption is very unusual,” McCabe said. Hence, he sees a correction of as much as 5% in the S&P; 500 index in the short term, as jittery investors are shaken out.
Fortis’ Poling, however, believes that whatever selling fever remains in the market is a product of the calendar, not widespread investor concern about interest rates. It’s hardly unusual that investors are taking profits in stocks near the end of the year, he noted. “This goes on, in different forms, every year at this time,” he said.
Paul Wick, who manages the Seligman Communications and Information stock fund in New York, agrees. With 20% of his $90-million fund in cash, he has ample buying power--and he said he started to use it last week, as many technology stocks plunged.
“I see a lot of great companies with real earnings and good balance sheets,” Wick said, citing such names as software designer Parametric Technology, and Xilinx, which makes semiconductors for telecommunications equipment.
What’s the best advice for the average investor? If you have a high comfort level about your stocks and/or stock funds heading into a stronger economy in 1994, then trying to exit and re-enter the market during the course of a short-term correction is probably more work than it’s worth.
But note: This bull market is aged, by any measure. Money you now have in stocks had better be committed to the end of the ‘90s, because between here and there some terrible turmoil surely lies.
Correction: A chart with last Monday’s column had an incorrect 12-month target price for Williams Cos. The correct figure is $38.
Expensive Stocks Get Less So
As the stock market has tumbled in recent weeks, many issues have fallen sharply relative to earnings. Bullish analysts say the slide is a buying opportunity, not the start of a bear market. Here’s a look at the decline in prices and price-to-earnings (P-E) ratios for 10 stocks, based on estimated 1994 earnings per share.
1993 Fri. Pct. P-E on ’94 EPS: Stock peak close chng. At peak Now Xilinx 54 1/2 38 -30% 28 19 Texas Instruments 84 1/4 59 3/8 -30% 15 11 Newbridge Networks 73 7/8 54 7/8 -26% 36 27 SunAmerica 46 1/2 36 1/4 -22% 14 11 Scientific Atlanta 38 7/8 30 3/4 -21% 26 20 Parametric Technology 44 3/4 35 1/2 -21% 42 33 Walt Disney 47 7/8 39 -19% 23 19 Sonat Inc. 36 1/2 29 7/8 -18% 19 16 Marvel Entertainment 35 3/4 30 -16% 24 20 Hong Kong Telecom 67 7/8 58 -15% 24 20 S&P; 500 index 469.50 462.60 -1.5% 16 16 Nasdaq compos. index 787.42 751.56 -4.5% NA NA
EPS (earnings per share) estimates are analysts’ consensus figures.
Source: Zacks Investment Research
