Repeat of ‘94? Or the Start of Something Different?
“This time it’s different.”
That has been been the mantra of stocks’ great bull market surge over the last two years, as Wall Street has sought to explain why share prices could march ever upward, in many cases to sky-high levels relative to earnings, without blinking.
One needed only to look around to find ample justification for the market’s hot streak--and for why it could continue indefinitely. The U.S. economy was in great shape, growing moderately; the world was mostly at peace; inflation had been slain; corporate earnings were robust; U.S. workers were amazingly productive; and aging baby boomers had little choice but to shovel their retirement savings into stock mutual funds.
Things were just plain different from what Americans had been used to in the 1960s, 1970s or 1980s. Things were a lot better--and stocks were merely reflecting that, in spades.
That was the bullish case, and it still is.
But with the violent decline in share prices over the last four weeks, many investors naturally have been forced to reconsider. Has something fundamental changed to irreparably harm the “this time it’s different” case for stocks--and to suggest that the market is teetering on the brink of a much deeper slide?
Certainly, the Federal Reserve Board’s widely anticipated decision to raise short-term interest rates on March 25, for the first time in two years, wasn’t expected to make stock investors feel cheery. Share prices are ultimately determined by interest rates’ levels and by underlying corporate earnings growth, and if rates are rising, that’s almost always burdensome for the stock market.
But in this 6 1/2-year-old bull market, neither the Fed’s doubling of interest rates in 1994 nor bond yields’ periodic swings of their own volition have hurt most stocks much, or for very long.
Should this time be different? By Friday, it seemed as if Wall Street was following the same script as in 1994 and last summer. In both of those pullbacks, the blue-chip Dow Jones industrial average dropped about 10% from its peak, then stabilized, setting the stage for another move up.
From the Dow’s all-time high of 7,085.16 on March 11 to Friday’s intraday low of 6,404.84, the index lost nearly 10% of its value. Then, as if on cue, the Dow rallied Friday, closing with a gain of 48.72 points to 6,526.07.
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End of sell-off? Some veteran Wall Street analysts don’t think so. Despite the carnage among technology stocks, some of which have lost 50% or more of their value in recent months, certain elements of the market’s latest slide appear far too civilized.
In other words, things are different, all right--but suspiciously different, rather than encouragingly different.
What many analysts hoped to see last week, for example, was a surge in trading volume as the Dow careened lower. High volume would have indicated that the sell-off had entered a “capitulation” phase, wherein frightened investors were dumping stocks in panic.
“What you need to see is a violent sell-off, then a big reversal” to suggest a bottoming trend, said Richard Eakle, head of market analysis firm Eakle Associates in Fair Haven, N.J.
But daily New York Stock Exchange trading volume last week never neared the 682-million-share total of last July 16, when the market began to bottom after its sharp summer pullback.
“People don’t seem to be that nervous. It’s surprising,” said Dan Sullivan, editor of the Chartist market newsletter in Seal Beach.
Nor have investors sought out the usual forms of “insurance” in this decline. Normally, some investors flock to stock “put” options when prices are plummeting, hoping either to cash in on the plunge or hedge their portfolios in case the slide continues.
A put option is a bet on a declining share price or share index, while a “call” option is a bet on rising prices.
On the Chicago Board Options Exchange, the ratio of puts to calls traded usually rises to 1.0 or greater when stock prices are tumbling, said Ricky Harrington, technical-market analyst at brokerage Interstate/Johnson Lane in Charlotte, N.C. But last week the ratio held at about 0.7, a level that suggests widespread investor complacency.
Bullish investors might very well argue that such complacency is a good thing. If people aren’t frightened they won’t sell, and the market will stabilize sooner, right?
Perhaps. But veteran Wall Streeters note that the market often does whatever it has to do to fool the greatest number of people. If investors expect that the market is certain to drop 10% but no more, the odds are high that a different scenario will unfold.
Dennis Jarrett, head of Jarrett Investment Research in Westport, Conn., worries that the market is set to rally for a couple of weeks, “Just enough to get people suckered in.” Then a deeper decline could begin, he said, one that would shock the complacency out of investors and reintroduce the element of fear.
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Of course, technical analysts can dissect the market like a laboratory animal and find all sorts of things to be momentarily fascinated by. But for the average investor, the only important question is whether there’s a fundamental problem for the bull market now--something big enough to turn mass psychology against paying current prices, let alone higher prices, for stocks.
On one count, investors should clearly understand that this is not 1994, when the Fed raised interest rates and the market overcame that with relative ease. Stocks were amazingly cheap at their lows in 1994 relative to earnings. That is not the case today.
William Dodge, strategist at money manager Marvin & Palmer in Wilmington, Del., believes that the “operative question” now for investors and their financial advisors is simply, “Where is the value?” for one’s investment dollar.
And when people ask that question, Dodge said, the answer increasingly is going to be either bonds, where yields have become much more attractive, or foreign stocks, which in many cases are cheaper than U.S. shares, and likewise in many cases have better earnings growth prospects if the rest of the world economy begins to follow the U.S. lead.
The long-term appeal of U.S. stocks hasn’t been dampened, Dodge believes. But in the short term he expects more pain for the market, as investors begin a much more intensive questioning of the “this time it’s different” faith that has sustained this aging bull.
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It’s Not 1994
Yes, stocks have pulled back sharply this year in the face of higher interest rates--as they did in 1994. But look at the lows these blue-chip issues reached in 1994, and their price-to-earnings ratios at those lows (based on 1994 earnings per share). At current prices, the stocks’ P/Es based on estimated 1997 earnings are dramatically above the 1994 lows. *
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‘94 ’94 Fri. ’97 Stock low P-E close P-E Coca-Cola $19.38 20 $57.38 35 Walt Disney 37.88 19 73.75 27 Merck 28.13 12 86.88 23 Johnson & Johnson 18.00 11 54.63 22 General Electric 45.00 13 100.88 20 Hewlett-Packard 18.00 12 52.75 18 Exxon 28.13 15 101.88 18 Intel 28.00 9 145.00 18 Philip Morris 47.38 9 113.38 12 Caterpillar 44.38 9 79.13 12
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All stock prices adjusted for splits where applicable. Source: Value Line Investment Survey
