Wall St.’s Recovery Faces Test of Stamina
Wall Street’s first half of 2001 was a tale of two markets, neatly divided: a first quarter in which virtually every major stock sector lost ground and a second quarter in which nearly every sector resurged--in some cases, quite handsomely.
Investors who just take a snapshot of their equity portfolio’s net gain or loss in the first half may still find that they’re in the red, perhaps significantly. But it could have been, and probably was, a lot worse three months ago.
One statistic speaks volumes about the market turnabout: The technology-dominated Nasdaq composite index’s 17.5% gain in the second quarter was the first advance in five quarters.
Though that is no guarantee that the bear market that began in March 2000 has finally run its course, the breadth of the second-quarter rally--at least until the last few weeks--impressed many Wall Street pros. Tech stocks led the way, but investors were buying much more than tech.
The average general U.S. stock mutual fund rose about 8% in the quarter, according to preliminary data from Lipper Inc. That pared the year-to-date loss to about 6.6%.
The rebound on Wall Street mirrored the shift in sentiment about the U.S. economy. By the first week of April, when most broad stock indexes bottomed, many investors had given up hope that the Federal Reserve’s aggressive credit-easing campaign could keep the economy out of recession.
Now, after six rate cuts in six months, the economic data overall have begun to appear less dire. Consumers’ confidence is rising, and they still are spending at a decent rate, to the surprise of many analysts. And in the severely depressed manufacturing sector, there are signs that the worst may be over.
For example, a report Friday from Chicago-area corporate purchasing managers showed that though business activity continued to ebb in June, the rate of decline slowed sharply.
Even if the economy is beginning to revive, however, it probably was too late to help second-quarter corporate earnings. At the start of the quarter, investors expected results to be weak, but expectations had to be further reduced over the last month amid a barrage of warnings from companies about poor sales and rising costs, especially for energy.
That could test the market in July as final results are reported.
But investors are supposed to look ahead, not backward. The bullish camp on Wall Street continues to argue that the market’s recovery since March is foretelling an economic recovery by year-end--and with it renewed growth in corporate earnings, which are what ultimately underpin share prices.
The problem with the bullish case is that it assumes that the people who have jumped back into the market recently are primarily patient, long-term investors who are buying stocks for 2002 and beyond, not for next week.
Yet for all the bulls know, the market could be largely at the mercy of short-term speculators--traders looking to play trends for a quick profit, then hop to something new or to the safety of cash.
Indeed, the first half was marked by a series of twists and turns that suggested many market players had no interest in staying invested for long. Anyone hoping for a fast return to the sustained bull market of the late 1990s was sorely disappointed.
In January, for example, the Nasdaq composite zoomed 12.2%, fueled by the Fed’s first interest rate cut. Likewise, investors poured into corporate junk bonds again, despite soaring default rates in the weakened economy. Risk-taking seemed to be back in vogue in a big way--a bet that the economic outlook could only improve.
But the rallies in Nasdaq and junk soon faded, and by February both markets were crumbling anew, along with expectations for the economy. By the time the first quarter ended Nasdaq had suffered an additional 25.5% decline after a 32.7% plunge in the fourth quarter.
In April and May, buyers returned in droves to Nasdaq and the stock market in general, as well as to junk bonds. Wall Street wanted to believe that the worst finally was over. From its two-year low April 4, Nasdaq leaped 29% by the end of that month.
Since mid-May, however, share prices have struggled again. The blue-chip Standard & Poor’s 500 index, at Friday’s close of 1,224.38, has slid nearly 7% from its spring peak reached May 21.
The Nasdaq index also is off about 7% from its peak reached May 22.
Still, the market has held on to the bulk of the gains made early in the second quarter. And the breadth of the advance has been encouraging for the bullish case.
Of 87 stock industry groups within the S&P; 500 index, 63 posted gains in the quarter while 24 posted losses.
The numbers are even more dramatic for S&P;’s indexes of small- and mid-size stocks. Within the S&P; small-cap 600 index, 75 stock industry groups rose in the quarter while 17 fell. In the S&P; mid-cap 400 index, rising groups outnumbered those falling 49 to 7.
The strength of smaller stocks relative to blue chips has been a major shift on Wall Street since mid-2000. Big stocks dominated in the bull market of the late ‘90s, but investors now are hunting much more aggressively down the corporate food chain for bargains and for companies offering faster growth.
Though a majority of stock groups in the S&P; 500 rose in the quarter, for the first half overall 44 groups fell while 43 rose.
Within the S&P; mid-cap and small-cap indexes, by contrast, winners dominated in the first half as well as in the second quarter.
Another trend that started in spring 2000--investors’ preference for “value” stocks over “growth” stocks--began to wane in the second quarter.
In the first quarter, mutual funds that focus on value stocks (typically shares selling for lower-than-average valuations as measured by price-to-earnings ratios and other barometers) performed far better than funds focused on growth stocks (typically higher-valued issues from faster-growing firms).
But in the second quarter, growth stocks outdistanced value stocks, though both groups rallied.
Preliminary data from Lipper Inc. show that the average large-cap growth stock fund rose about 6.1% in the quarter, versus a gain of about 3.9% for large-cap value funds.
Among small-cap funds, growth-focused funds returned about 14% in the quarter, on average, versus about 11.6% for value funds.
Investors’ willingness to buy growth stocks again, especially technology issues, is another sign that the fear level in the market is declining.
Still, this summer could bring a critical test of the staying power of recent buyers and of long-term investors as well, analysts note.
The Federal Reserve is widely believed to be nearing the end of its credit-easing campaign. If investors can’t look forward to deeper rate cuts this summer, while a meaningful revival of corporate earnings growth isn’t likely before 2002, the market could find itself in the same pattern of the first half: Recent risk takers may be quick to pull the trigger if they think their short-term gains suddenly are threatened.
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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.
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Nasdaq Turns
The Nasdaq composite stock index rose 17.5% in the second quarter, its first advance since the first quarter of 2000.
Nasdaq composite, quarterly percentage changes
2001
2nd quarter: +17.5%
Source: Bloomberg News
Smaller Still Looks Better
Small- and mid-size stocks far outperformed the blue-chip Standard & Poor’s 500 index in the second quarter and year to date, continuing a trend that began in mid-2000.
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First-Half Stock Group Performance
Within the blue-chip S&P; 500, the number of stock industry groups rising in the first half was nearly even with the number falling. But rising groups outnumbered losers in the mid-cap S&P; 400 and the small-cap S&P; 600.
Source Bloomberg News
Second-Quarter Sector Leaders
The turnaround on Wall Street in the second quarter was led by deeply depressed technology issues, but investors snapped up issues in many sectors beyond tech.
Source: Bloomberg News
