A Rough Time All Around for Stocks

The global stock bull market hit some large speed bumps in the third quarter, jarring share prices almost everywhere.

The good news: Most equity markets still are hanging on to gains for the year. But that’s little consolation for anyone who bought near stocks’ 1999 peaks--especially in the case of many U.S. blue chips.

Despite bargain hunting that lifted the Dow Jones industrial average 123.47 points, or 1.2%, to 10,336.95 on Thursday, “correction” was the operative word on Wall Street and in many foreign markets last quarter.

The Dow now has slumped 8.7% from its record high of 11,326.04 reached on Aug. 25. Many formerly red-hot emerging markets have suffered much worse. The Mexican market has dived 18% from its 1999 peak, while South Korean shares have tumbled nearly 21% from their highs.

Year to date, the Dow is up 12.6%. The average U.S. stock mutual fund is up somewhere in the neighborhood of 5%. But at midyear, the average fund was up better than 11%.

Looking for someone or something to blame, Wall Street is pointing to most of the usual suspects, including interest-rate worries (after two Federal Reserve rate hikes since June 30) and jitters over corporate earnings growth.

But other potential culprits are in the lineup this time: a surge in prices of commodities, including oil and gold, which at the very least are competing with stocks for some investors’ dollars; a sharp downturn in corporate takeover activity; a continued slowing of new investment in stock mutual funds; and increasing concern that many stocks are simply overpriced.

Indeed, the drop in takeover activity, while perhaps a natural reaction to rising borrowing costs, also suggests that corporate managers are worried about paying too much for other companies.

Microsoft President Steven Ballmer triggered a deep sell-off in many major tech stocks last week after he called tech valuations “absurd.”

But technology has been the least of the broad market’s worries. The tech-heavy Nasdaq composite index, though down 4.9% from its Sept. 10 record, actually gained 2.2% in the third quarter.

The most severe damage in the U.S. stock market this year has been inflicted on many once-invincible blue-chip multinationals, including Coca-Cola, Gillette and Avon Products. Despite the booming U.S. economy and a recovery in much of Asia, sales and earnings at those companies as well as other giants have stalled at best, and declined at worst.

Many investors are concerned that the problems at the likes of Coke and Gillette might be foreshadowing the next turn for the market overall. But based on Wall Street’s estimates for third-quarter earnings growth at blue-chip companies in aggregate, those fears appear to be misguided.

Earnings tracker First Call says analysts now expect total operating earnings growth of 19% for the Standard & Poor’s 500 companies in the third quarter versus the same period in 1998.

That would be the best earnings growth since the first quarter of 1995, the research house says.

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Then why can’t Wall Street get its motor running again? Don Hilber, economist at Wells Fargo in Minneapolis, argues that “very rapid earnings growth has already been built into prices”--the basic argument that Microsoft’s Ballmer appeared to have made.

If that’s true, then anything that qualifies as a negative for stocks becomes a reason, potentially, for investors to lower the prices they’re willing to pay for shares relative to underlying earnings.

That’s classic securities analysis, anyway. But as many investors know, classic securities analysis, and Wall Street’s long-standing “rules” of stock valuation, have gone out the window in the 1990s.

Are they coming back home to roost now? If so, with stock prices still historically very high relative to earnings, there are good reasons to imagine that the market will struggle in the months ahead--especially with worries over the year-2000 computer bug likely to fester all the way to Jan. 1, and perhaps beyond.

The market’s bulls, however, take the view that we’ve simply endured a typical market correction in the third quarter. History, they note, shows that the third quarter is typically the toughest for the U.S. stock market.

Over the last 20 years, the S&P; 500 index has, on average, posted a mere 1.4% gain in the third quarter. By contrast, the average gains in the first, second and fourth quarters were 4.3%, 4.1% and 4.4%, respectively.

(The last 20 years, it should be noted, have been far better for blue-chip stocks than the preceding 60 years.)

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Is there a natural catalyst for a fourth-quarter market rebound? Some pros look to the Federal Reserve, which meets on Tuesday. The betting is that the Fed will opt not to raise interest rates again, perhaps in part because the stock market is already on the ropes and in part because there are some, if few, signs that the economy is slowing.

A restrained Fed is often Wall Street’s best friend. But that also raises the ante: If the Fed stays sidelined and stocks don’t rally, the longevity of the 9-year-old bull market will be all the more in question.

A look at some winners, losers and other highlights of the third quarter:

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Foreign stock markets: Emerging markets, the stars of the first half as it became clear that Asia was beginning to recover after a two-year depression, suffered profit-taking along with U.S. stocks.

Latin American markets were among the hardest hit. Brazil’s market was up as much as 86% (in local currency terms) at its 1999 peak. It’s now up 64%.

South Korean shares have tumbled in recent weeks as the country deals with the downside of recovery--mainly, rising interest rates.

Among developed markets, European stocks have surrendered part of what had been paltry first-half gains.

Interestingly, however, takeover mania in Europe hasn’t faded to the extent it has in the United States. The dollar value of European mergers announced in the third quarter was a record, at $383 billion, according to Thomson Financial Securities Data. Whether that continues, and puts a floor under European stock prices, remains to be seen.

Japanese stocks, meanwhile, have stood their ground better than most, as money has poured back into Japan in a bet on sustained economic recovery. (That’s also what’s behind the strong yen, which began the quarter at 120.93 to the dollar and ended at 106.77.) The Nikkei-225 blue-chip index ended Thursday at 17,605, slightly above its June 30 close.

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U.S. bond markets: After peaking in August, yields on Treasury securities have declined even in the face of the upcoming Fed meeting.

The 30-year T-bond yield ended Thursday at 6.05%. That is up just marginally from 5.97% at June 30 and down from a peak of 6.28% on Aug. 12. The two-year T-note yield has inched up from 5.54% to 5.59% since June 30.

But the Treasury market has benefited from Y2K jitters, attracting money that is looking for a safe place to rest, many bond traders say.

The true story of interest rates in the quarter is told by the corporate junk bond market. The yield on the KDP index of junk bonds stands at 10.64%, up from 9.88% at the end of June.

Even savers are doing better: Average six-month bank CD yields nationwide are about 4.52%, versus 4.23% at June 30, according to IBC Financial Data. Though in only a small way, it represents more competition for stock market dollars.

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U.S. smaller stocks: A surprise in the quarter was that smaller stocks didn’t fare worse, given the market’s sudden case of nerves. The S&P; small-stock index fell 5% and is down 7.3% from its 1999 high. But the blue-chip S&P; 500 lost 6.6% for the quarter and is off 9.6% from its peak.

Bulls argue that smaller stocks’ ability to hold up better than blue chips bodes well. But many analysts note that the vast majority of U.S. stocks have been sinking in recent weeks, if not as fast as the blue chips.

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Commodities: There’s a good argument that stock markets worldwide could be doing a lot worse, given the surge in crude oil prices. Near-term crude futures in New York ended Thursday at $24.51 a barrel, up from $19.29 at June 30 and $16.76 at March 31.

But commodity prices overall haven’t gained that much this year. The Commodity Research Bureau index of 17 commodities (including oil, grains, gold, cattle and other items) is up 7.1% since June 30 and 7.3% since Jan. 1.

It would have to rise an another 17% just to return to the levels of the mid-1990s.

Tom Petruno can be reached by e-mail at tom.petruno@latimes.com

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Third-Quarter Curse?

Just as in the 1998 period, stocks took a dive in the third quarter ended Thursday. Fears over interest rates, corporate earnings and rising commodity prices weighed on markets worldwide. On Wall Street in particular, high stock valuations finally seemed to give some investors pause.

Declines in major blue-chip shares vs. key U.S. stock indexes:

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52-week Thurs. % Stock high close drop Intel $89.50 $74.31 -17.0% Hewlett-Packard 118.44 90.75 -23.4 MCI WorldCom 96.75 71.88 -25.7 AT&T; 64.06 43.50 -32.1 Coca-Cola 75.44 48.25 -36.0 Safeway 62.44 38.06 -39.0 Clorox 66.44 38.25 -42.4 Bank One 63.56 34.81 -45.2 Gillette 64.38 33.94 -47.3 Avon Products 59.13 24.81 -58.0 Nasdaq composite 2,887.06 2,746.16 -4.9% S&P; small-cap 190.15 176.20 -7.3 Dow industrials 11,326.04 10,336.95 -8.7 NYSE composite 663.12 592.79 -10.6 S&P; mid-cap 427.82 380.59 -11.0

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The S&P; 500 Takes a Hit ...

Quarterly price changes:

3rd quarter 1999: -6.6%

Gains in major stock indexes, first half of ’99 and year-to-date through Thursday, in local currencies:

South Korea

First half 1999: +57%

Year-to-date: +49%

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Mexico

First half 1999: +47%

Year-to-date: +28%

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Hong Kong

First half 1999: +35%

Year-to-date: +27%

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Japan

First half 1999: +27%

Year-to-date: +27%

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U.S. (S&P; 500)

First half 1999: +12%

Year-to-date: +4%

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Germany

First half 1999: +8%

Year-to-date: +3%

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Britain

First half 1999: +7%

Year-to-date: +3%

Sources: Times research, Bloomberg News

Waning Urge to Merge

The number of announced merger deals involving U.S. companies fell in the third quarter to its lowest level since at least the mid-1990s, while the dollar value of deals announced was the lowest since the first quarter of 1998. Quarterly data, including third-quarter figures through Tuesday:

Number of Deals

Third-quarter 1999: 2,453 merger deals

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Value of Deals (in billions)

Third-quarter 1999: $315 billion

Source: Thomson Financial Securities Data

Coming Tuesday

The bull-market marathon may be ending, but opportunities still abound. Plan your strategy with The Times’ quarterly financial report, featuring investment ideas and lists of top-rated mutual funds from Morningstar Inc.