NEWS ANALYSIS : Stock Market Plunge Masks Deeper Woes
The phenomenal U.S. stock market rally of the 1990s, a boon not only for Wall Street but for many average Americans as well, may be facing the toughest challenge yet to its longevity.
In a flurry of selling on Thursday, the Dow Jones industrial average tumbled 83.11 points to 5,520.54, bringing its loss over the past five sessions to a sharp 182.48 points, or 3.2%.
Although a decline of that magnitude isn’t unusual in the history of the widely watched Dow, it masks a much deeper slide in the market as a whole.
More ominous, stocks are being pummeled not because of a single factor but because of several which, combined, could rapidly erode investors’ willingness to hold stocks in the short run, some warn.
Higher interest rates, for example, are siphoning big investors’ dollars away from stocks and into fixed-income securities, such as bonds. And small investors have suddenly reduced their purchases of stock mutual funds after pumping record sums into the funds between January and May.
But perhaps Wall Street’s greatest concern is that the boom in U.S. companies’ profit growth over the past three years is coming to an abrupt end, undermining one of the key props supporting stocks.
Thursday’s market plunge was sparked by technology giant Hewlett-Packard Co.’s disclosure that orders for its computers and other equipment have unexpectedly slowed, threatening its earnings.
H-P’s announcement followed similar downbeat reports from other technology firms in recent weeks, including Motorola Inc.
In addition, analysts have grown increasingly suspicious about the potential for disappointing second-quarter earnings from many other industries. Most firms will report results in the next few weeks.
In the cereal business, for example, a price war broke out in the second quarter as major food companies slashed supermarket prices. Mining companies also have faced sharply lower prices for basic metals, such as copper and silver. Even companies producing generic drugs have been hurt by surprising pricing weakness for their products.
The worry about a corporate profit squeeze caused by pricing pressures seems at odds with the tone of the U.S. economy in the first half, as most economic data has pointed to a resilient business environment stoked by a still free-spending consumer.
But some experts think the profit problems can be explained rather simply: Competition among companies has continued to intensify, while at the same time a tight U.S. labor market is forcing companies to boost some workers’ wages.
Hence, “production costs have been rising but [retail] prices for products have not kept pace,” said James Solloway, strategist at Argus Research Corp. in New York.
The idea of growing upward pressure on wages was strongly suggested last Friday, when the government reported that average hourly earnings rose in June at the fastest pace in 30 years.
Many economists, however, doubt that wages are in fact rising so rapidly. They also warn against broad conclusions about earnings’ weakness: Companies with bad earnings news often telegraph that early in the quarter--so that better earnings reports tend to be the rule as the quarter progresses.
Still, there is little question on Wall Street that U.S. companies’ overall earnings growth this year will be well below the spectacular gains of recent years, when profits were boosted in part by extensive cost-cutting and downsizing.
Standard & Poor’s Corp. estimates that earnings for its 500-stock universe of blue-chip companies will grow about 9% this year, after surging 16% in 1993, 16% in 1994 and 17% last year.
Because the promise of future earnings growth is the principal reason to own stocks, the profit slowdown automatically causes more investors to question how much stocks are truly worth.
And given the stunning leap in the market over the past 18 months--the Dow index rose 33.5% last year, and gained another 10.5% in the first half of this year--many analysts say it shouldn’t surprise anyone that investor jitters over corporate earnings should cause profit-taking.
Indeed, historically, such “corrections” within bull markets can lop 10% to 15% off indexes like the Dow, before stocks stabilize.
“This may be a typical ‘sale’ that comes around every three years or so,” says Michael Burke, analyst at Investors Intelligence newsletter in New Rochelle, N.Y.
But some analysts worry that slowing corporate earnings growth will compound other problems now challenging stocks, leading to more severe selling that could produce a true bear market--usually defined as a drop of more than 15% in indexes like the Dow.
The last bear market occurred in 1990, when the Dow plunged 21% after Iraq invaded Kuwait. The Dow has soared 133% from its 1990 lows, and the vast majority of investors now in the market have entered along the way--meaning they have no experience with the pain of a real bear market.
Among the major threats to the bull market’s health now:
* Yields on Treasury bonds and other fixed-income securities have risen sharply this year, responding to the stronger economy and anticipating that the Federal Reserve Board may have to tighten credit to slow activity and keep inflationary pressures from building.
Many economists believe that bond yields are poised to decline again, because they expect the economy to slow in the second half. “I think bonds have priced in the worst [possibilities]” now, said William Dodge, strategist at Marvin & Palmer in Wilmington, Del.
But if yields fail to fall back, or the Fed indeed tightens credit, the result will be that bonds will present ever-greater competition for investors’ dollars.
* Speculation in smaller stocks became extraordinary in spring, as investors bid prices up in a frenzied search for high-growth stocks.
Now, many of those same small stocks are crashing as investors rush to take profits. The result is that the Nasdaq composite index of mostly smaller stocks has already plummeted 11.4% from its record high, while the blue-chip Dow index is down 4.5% from its peak.
“Investors just went after stocks that had price momentum, and now they’re being punished,” said Rao Chalasani, strategist at Everen Securities in Chicago.
The fear is that a continued implosion in smaller stocks will create the image of a general market meltdown, frightening more investors away.
* Cash inflows into stock mutual funds have slowed, suggesting that individuals have grown more wary about the market.
The mutual funds’ chief trade group estimated Wednesday that stock funds took in $15.5 billion in June, down 38% from May and the lowest total yet this year.
Small investors’ seemingly insatiable appetite for stock funds has been one of the major driving forces of the 1990s bull market, as aging baby boomers have ramped up their savings for retirement.
No one expects that flow of money to simply shut off. Retirement money “is not something that ebbs and flows,” notes Alfred Kugel, strategist at Stein, Roe & Farnham in Chicago. Rather, many investors buy stock funds through automatic payroll-deduction plans such as 401(k) savings programs.
Even so, the June decline in stock-fund inflows indicated that more investors who buy stocks outside retirement accounts have become more cautious.
Despite these threats to the 5 1/2-year-old bull market, plenty of analysts believe the current sell-off will quickly run its course. To generate a full-scale bear market decline, “I think you need a bigger problem with corporate earnings or with interest rates, and I don’t see it,” said Dodge, who expects bond yields to drop soon.
Solloway thinks nervous investors may slice another 5% off blue-chip stock prices. If he’s right, he noted, “This [drop] is half over.”
The key question, said Everen’s Chalasani, is whether the mentality of most investors so far in the 1990s--to buy stocks when they drop--has somehow been altered.
“The issue is whether we’ve gone from ‘buy every dip’ to ‘maybe I shouldn’t be buying every dip’ ” he said.
* INDUSTRY UNSETTLED: Technology outlook mixed. D1
* STOCK DECLINE: A closer look at the sell-off and what to do about it. D3
