Investors Have Cause to Hesitate on Stocks
The 1990s bull market wrote its own rules and thumbed its nose at historical precedent.
So perhaps it shouldn’t surprise anyone that the market that has followed is doing much the same thing.
Just as major stock indexes rose far higher and faster in the late 1990s than seemed possible in the context of Wall Street’s historical frame of reference, the market isn’t following the classic script in its bear market/recovery phase (take your pick as to whether the current situation is more “bear” or “recovery”).
Given the Federal Reserve’s six interest-rate cuts this year, history says the market should have rallied significantly by now.
Instead, the blue-chip Standard & Poor’s 500 index, at 1,214.35 on Friday, is 5.4% below its level on Jan. 2--one day before the Fed’s first rate cut.
The Nasdaq composite, at 2,066.33 on Friday, is 9.8% below its level on Jan. 2.
How unusual is that? Since 1971 there had been 13 Fed rate-cutting cycles before this year’s, meaning periods during which the central bank reduced short-term rates two or more times in succession.
In 10 of those 13 periods, the S&P; 500 was higher six months after the first Fed cut. Ditto for the Nasdaq index. That’s a 0.769% batting average--about as good a predictive record as an investor can hope to find.
(Of course, we’re now seven months past the first Fed cut, but the S&P; and Nasdaq were down as of the actual six-month anniversary on July 3 as well. And though many stock sectors, especially small- and mid-capitalization sectors, have posted gains this year, the average U.S. stock mutual fund still is down 8.6% year to date, according to Morningstar Inc.)
From 1971 through 1999, the average gain in the S&P; 500 six months after initial Fed rate cuts was 12.4% and the average gain in the Nasdaq was 16.2%.
What’s more, 12 months after initial Fed cuts in those years, the stock market’s recovery has historically been in full bloom, with an 18.6% gain in the S&P; 500 and a 27.1% gain in the Nasdaq, on average.
For the market just to match those historical benchmarks by Jan. 3, 2002--less than five months away--a spectacular rally would have to ensue. The S&P; would have to rise 25% from its current level and Nasdaq would have to rocket 41%.
Though they are a distinct minority, some Wall Street pros don’t view those targets as outlandish.
One is Abby Joseph Cohen, a veteran Goldman Sachs Group strategist. Last week she reiterated her year-end target of 1,550 for the S&P; 500, which would mean a 28% rise from Friday’s close.
In particular, “It’s an excellent time to look at technology,” Cohen said on CNBC-TV.
Some investors were doing just that last week, at least until Friday. Semiconductor stocks led a broad rally in tech for much of the week, lifting the SOX index of 16 major chip stocks 6.5% for the week. On Thursday the SOX reached its highest level since June 8, and chip leader Intel reached its highest level since mid-April.
The impetus was industry chatter that depressed chip sales may have reached their nadir, and that an upturn in orders may be in the wings. Intel Chief Executive Craig Barrett told reporters at a news conference Thursday in Malaysia that “the industry has bottomed out,” a day after brokerage Merrill Lynch upgraded a dozen chip stocks on expectations of a sales turnaround.
If the chip stock revival continues in the weeks ahead--and signs of a turnaround in chip orders follow in September--it could give the market’s bulls much more ammunition. A further rally in stocks could restore faith in the market’s ability to forecast economic turns. More important, actual signs of a turn in the manufacturing sector (especially for tech-equipment orders) would restore faith in the Federal Reserve’s power to fix what ails the economy.
History says investors should be willing to jump back into stocks even while corporate earnings are falling--as long as a glimpse of recovery is on the horizon.
If that doesn’t hold true this time around, it would mean the market’s mind-set has been radically altered, which would hardly be comforting for anyone trying to take a bullish view of stocks either for the short term or the long term.
Second-quarter corporate earnings were disastrous overall, which was largely expected given the weak economy. Through last week 88% of the companies in the S&P; 500 had reported quarterly results, and operating earnings for the reporting firms were down 15.7%, on average, from a year earlier, according to Thomson Financial/First Call in Boston.
Wall Street analysts also continue to slash estimates for the current quarter and for the fourth quarter, according to estimate-tracker Joe Cooper at Thomson. Overall, analysts now expect the S&P; 500 companies to report third-quarter results down 12.4% from a year earlier. As of July 1 the forecast was for a drop of half that amount.
For the fourth quarter, S&P; 500 earnings are expected to be flat compared with a year earlier, instead of the 5.5% growth analysts had been projecting on July 1.
Why should investors be cheered by the new estimates? If those figures are in the ballpark, they would suggest that the rate of decline in earnings is slowing--and that year-over-year results might even begin to show growth in 2002.
Yet investors have all sorts of good reasons either to doubt earnings estimates or to reject plowing more money into stocks even if they believe the estimates.
Start with the increasingly tarnished reputation of analysts in general, amid ongoing congressional hearings into the alleged lack of objectivity shown by analysts during the technology-stock bubble of 1999 and early 2000. Last week the Securities and Exchange Commission released a report showing that 28% of analysts the agency surveyed had purchased stock at sweetheart prices before recommending the shares to the public at large.
Analysts might argue that their ownership was a sign that they really liked the stocks. But the SEC survey also showed that at least three analysts were selling their personal shares while still recommending that John Q. Public buy them.
Even if analysts are accurate in their earnings projections, actual earnings reports these days are leaving many investors baffled as to what a company’s true bottom line may be. A simple net income figure can be hard to find amid language referring to “pro forma earnings” and operating earnings, which can vary dramatically from company to company in terms of what’s included from ongoing corporate operations and what’s considered a “one-time” gain or loss.
Walt Disney Co. reported its quarterly results Thursday. On Friday, The Times said Disney’s income before extraordinary charges was down 3% from a year earlier. The Wall Street Journal said net income rose 8.6%. Daily Variety said the company’s pro forma earnings were down 26%. Who was right? Everyone--depending on which Disney data you use.
But pity the investor trying to determine a fair share price to pay based on current earnings or on expected earnings growth.
No wonder many potential investors have simply opted for the sidelines in recent months--what some Wall Streeters call a “buyers’ strike.”
Investors who aren’t suspicious or confused may feel that the market’s biggest problem is that it’s still expensive by historical standards.
The average blue-chip stock is priced at about 20 times this year’s estimated operating earnings per share. New bull markets typically haven’t started at valuation levels this high. If, even as corporate earnings begin to improve, stocks fail to rally much--or fail to hold on for long to any rally gains--it would suggest that investors just don’t have enough faith in long-term corporate earnings growth to pay share prices much above these levels.
In the face of lower interest rates and rebounding corporate earnings, that would be a rare occurrence indeed. But then, this market has been one rare occurrence after another since the mid-1990s.
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Tom Petruno can be reached at tom.petruno@latimes.com. For recent columns on the Web, go to https://www.latimes.com/petruno.
