Wall St. Just as Unsure as Economy

Wall Street gets back to business this week to confront a stock market that appears in far weaker shape than when the summer began.

Much like the economy, however, the market has been throwing off mixed signals about its status--and about what it might do next.

Key indexes, including the Dow industrials and the technology-heavy Nasdaq composite, have slumped since June 1, and by last week were nearing the two-year lows set in late March and early April. The Dow closed at 9,949.75 Friday and Nasdaq ended at 1,805.43.

Yet consistently this summer more New York Stock Exchange issues have been hitting new 52-week highs than new lows. And indexes of small and mid-size stocks still appear to be in bull markets, or at least not in bear markets: The Standard & Poor’s small-cap index is up 1.6% year-to-date, while the S&P; mid-cap index is down 4.5%.

By contrast, the blue-chip S&P; 500 is off 14.1% year-to-date.

Is the market’s glass half full or half empty? Here’s a look at some of the trends beneath the surface, and what they may mean for Wall Street’s next move:

* Breadth: When analysts measure breadth in the market, they look at the number of stocks, and stock sectors, that are moving higher versus the number moving lower. Because major indexes can be skewed by the moves in a relative handful of big stocks, breadth can tell the true tale of demand for stocks across the spectrum.

The latest data aren’t particularly encouraging, some analysts say. Last week, 2,089 NYSE-listed stocks fell while 1,279 rose; on Nasdaq losers swamped winners by nearly 2 to 1.

The deterioration in breadth has been going on for weeks. For all of August, 63 of the 87 stock industry groups within the S&P; 500 posted lower share prices, on average, according to Bloomberg News data.

What’s more, winning groups in the last month mainly were classic “defensive” market sectors--that is, sectors that often have held up best in bear markets. Those groups include stocks in health maintenance organizations, tobacco and packaged food.

Leadership by those sectors suggests more investors are hunkering down for a longer bear market.

Of course, that doesn’t mean those investors will be right. Indeed, Wall Street’s bulls say market pessimism has reached such high levels that a rebound in prices is all but assured this month--precisely because most people don’t expect one.

But there’s also a risk that those newly popular defensive stock sectors will be the last market pillars to fall, especially if consumer spending is petering out.

“Soon the new source of disappointment and bad news . . . may switch to the consumer and the ‘old economy,’ and the defensive groups that have held up so well,” Barton Biggs, veteran market strategist at Morgan Stanley Dean Witter in New York, wrote in a recent report to clients.

What about all those NYSE stocks hitting new 52-week highs? Last week, 348 NYSE shares hit new highs while 150 hit new lows.

But the issues dominating the new-highs list are so-called preferred stocks--high-dividend-yield shares that do best when investors are seeking safety and avoiding risk. That isn’t a bullish sign, analysts say.

* Smaller stocks versus larger stocks: Overall, small and mid-size stocks have continued to hold up much better than big-name stocks this year, which reflects investors’ rediscovery of smaller shares in the last 18 months after mostly ignoring them in the late 1990s.

But even within the small and mid-size stock universe prices have been weakening in the last month. The S&P; small-cap index fell 2.6% in August while the S&P; mid-cap index lost 3.6%. Much of the damage occurred just last week.

The poor economy is catching up with smaller companies’ earnings: Wall Street analysts now expect the average company in the S&P; small-cap index to post third-quarter earnings 19.9% below year-earlier levels, according to earnings-tracker Thomson Financial/First Call in Boston.

By comparison, the expected earnings decline for the blue-chip S&P; 500 companies this quarter is 14.2%, Thomson says.

The risk is that earnings concerns might cause investors to reduce their stakes in smaller stocks. But market optimists say many investors might instead decide that lousy earnings are the rule rather than the exception for the moment, and thus that there is no point fleeing smaller stocks for other market sectors.

* Growth versus value: Technology shares have led the crash in “growth” stocks over the last 18 months--that is, stocks of companies whose earnings have historically grown faster than the market average.

Burned by growth names, more investors have turned to “value” stocks, typically unloved or underappreciated shares of slower-growing companies.

Value stocks resurged in 2000 and they have continued to perform better than growth stocks this year.

The average mid-cap value stock mutual fund is up 2.3% year to date, while the average mid-cap growth fund is down 24.1%, according to fund-tracker Morningstar Inc.

But many value stocks faded in summer with the rest of the market. The S&P;/Barra index of the 343 stocks in the S&P; 500 classified as value issues lost about 14% between late May and Friday, and now is down 10.6% year-to-date.

(That’s still better than the S&P;/Barra growth-stock index, which is down 17.7% this year.)

A key challenge for investors today is deciding what constitutes true value. For example, the S&P;/Barra value stock index includes those S&P; 500 shares that have lower-than-average price-to-book ratios--a measure of a stock’s price relative to the estimated per-share value of the company’s net worth. The index doesn’t use price-to-earnings ratios as a criteria.

Based on price-to-book ratios, technology giants such as Broadcom Corp. and JDS Uniphase are in the S&P;/Barra value-stock index, even though many investors still consider them growth issues.

Using price-to-earnings as a gauge of the market’s appeal, investors find many stocks still selling at P/E ratios that are historically high.

The S&P; 500 index, for example, is priced at about 20 times expected 2001 earnings. New bull markets have usually started at much lower average P/Es, analysts note.

“Valuation looks questionable at best,” says Richard Bernstein, chief quantitative analyst at Merrill Lynch & Co. in New York.

Investors should be especially wary of technology stocks still selling for high P/Es, Bernstein suggests.

Noting the late-1990s surge in the sheer number of tech companies competing in the marketplace, Bernstein warns that “if profitability does rebound in the tech sector, that rebound will have to be shared with about 50% more companies than in 1998.”

In other words, greater competition is likely to mean thinner earnings for tech players even when sales begin to pick up again.