Bears Insist the Bottom’s Yet to Come

Wall Street’s bears smell blood in the wake of the stock market’s dive to near-three-year lows, and some are predicting horrendous losses yet to come in share prices.

Some even see the technology-dominated Nasdaq composite index falling below 1,000, which would be a decline of 40% or more from current levels. The index already has plunged 67% from its peak in 2000.

Though most market veterans believe stocks are close to bottoming, the bears note that the optimists have made that argument many times in the last year and have been consistently wrong.

Friday, the blue-chip Standard & Poor’s 500 index fell through its April low, officially extending to 18 months the bear market that began in March 2000. The government’s report of a surge in unemployment in August was the trigger for the latest sell-off.

The Nasdaq composite index closed at 1,687.70 Friday, not far above its April low of 1,638.80.

Tech stocks, which have borne the brunt of the market’s pain so far, are poised to go lower, many bears contend.

They say that too many tech investors are enacting a classic “flight to safety.” As the economy falters and the outlook for sales and profits withers, the hot theme is survivability: Some bullish Wall Street strategists advise shifting from smaller tech stocks to the ones with the biggest cash hoards, the top market shares, the most unassailable reputations--IBM Corp., Intel Corp., Microsoft Corp., Applied Materials Inc. and other popular names.

These goliaths may stumble along the way, the story goes, but at least they’ll still be standing when the inevitable rebound comes.

That kind of thinking convinces analyst Fred Hickey that the tech bear market is nowhere near a bottom. He views the “flight to safety” as a move from a house of straw to a house of twigs.

“They’re buying extremely high-priced stocks because they’re safer than Amazon.com,” which isn’t saying much, he argues.

Hickey, New Hampshire-based publisher of the newsletter High-Tech Investment Strategist, has considered the sector overvalued since well before the Nasdaq index peaked 18 months ago. He can’t think of a single tech name he likes at today’s prices.

“Would I question that Applied Materials is the best company in its industry? Absolutely not,” Hickey said. But the maker of computer chip manufacturing equipment still sports a $32-billion market capitalization (stock price times shares outstanding) even as annual sales crumble toward the $4-billion mark.

A valuation of eight times sales would be high at a market top, and it’s absurd at this point in the economic cycle, Hickey said.

Individual stock valuations and broad market indicators must fall much further before the excesses of the recent tech mania are fully wrung out, Hickey and fellow bears insist.

Dallas money manager David Tice sees the market bottoming at a three-digit number: 500 on Nasdaq. That would imply a 70% drop from Friday’s close.

Blue-chip indicators, such as the Dow Jones industrial average and the S&P; 500, are hardly immune from further destruction, the bears say. The S&P; 500 stocks, on average, are priced at about 20 times this year’s estimated earnings, historically lofty even for market tops, let alone at bottoms.

“We’ve taken some of the air out, but there’s still another 50% [decline] to go in most of these big tech names and in the market as a whole,” said Seattle money manager William Fleckenstein.

“Look, everybody was a ‘momentum’ player, and now suddenly they’re all talking about ‘value’ and saying, ‘At least I’ve got the protection of a cheap stock,’ ” Fleckenstein said. “But when you try to play that game when things are still as high-priced as they are, it’s just not going to work.”

Tice, whose Prudent Bear fund (up 19% so far this year) specializes in “short selling,” or betting that specific stocks will fall rather than rise, sees nothing but bad news in the economic data.

With growth in the rest of the world flagging, with U.S. unemployment just posting its largest monthly jump in six years, with U.S. business already suffering their worst earnings slump in years, the bullish case for the economy rests mainly on two pegs: housing and consumer spending.

And how strong is housing? Tice and others believe that the tech-stock bubble also created a real estate bubble, at least in some parts of the country.

To be sure, the Federal Reserve’s credit-easing campaign has kept mortgage rates low and spurred real estate activity, but many homeowners have used the low rates to refinance their mortgages, taking equity out of their homes to fuel more spending.

A study by analyst Frederick J. Sheehan Jr. of John Hancock Asset Management Services found that U.S. homeowners now have a lower percentage of equity in their homes than at any time since World War II, despite soaring home values.

Incomes continue to rise, but the ability to pay debts is stretched taut: Monthly payments on mortgages and installment debt, as percentages of consumers’ total disposable income, both have reached all-time highs, exceeding even the peaks they hit during the “me” decade of the 1980s, Sheehan said.

That suggests it’s debatable whether Americans can even afford their own homes, let alone keep opening their wallets for more autos, airplane flights, restaurant meals and electronic gadgets, the bears say.

Undaunted, tech-stock enthusiasts keep trying to spot the glimmer of a turnaround. Computer chip leader Intel said last week that sales this quarter are holding up better than many analysts had expected.

But what’s really happening with semiconductors is best seen from the perspective of end users, Hickey said. RadioShack Corp., for example, said Friday that computer sales at its 7,000-plus company-owned stores were down 50% in August compared with a year earlier. Circuit City Group chimed in with a report that total sales were down 21% year-over-year for the quarter ended Aug. 31.

“If computers aren’t going out the door at Circuit City, then [regardless of orders] it’s just an inventory build for Intel,” Hickey said.

In another softening market for chips, cellular phone sales, which analysts once thought would hit 650 million to 700 million units this year, now look as though they’ll limp in at less than 400 million.

Hickey said he has been bullish on technology for most of his career and expects to be bullish again, but he believes now is a dangerous time for the sector and the stock market overall.

Retail investors are shrinking back, as demonstrated by the 50% plunge in stock trades at discount-brokerage leader Charles Schwab & Co. from a year ago. Lower trading volume means lower liquidity--the ability to buy and sell stocks without creating large price movements.

With retail investors on the sidelines, institutions are in charge of the stock market, and the pros are actually more prone to panic than individual investors, Hickey said. That’s why he expects September and October, historically two of the most challenging months for the stock market, to be especially harrowing this year.

There will be tech bargains again, perhaps as early as this fall, but for now it is better to stay in cash than try to ride out the storm by shifting to big and popular names whose safe appearance may be illusory, Hickey said.

Tice draws parallels to the “Nifty 50” market phase of the early 1970s, when investors crowded into “can’t-miss” growth stocks such as Coca-Cola Co., McDonald’s Corp. and Walt Disney Co. That was a flight to safety in the aftermath of a crash in many smaller stocks between 1968 and 1970.

The Nifty 50 episode ended with the brutal bear market of 1973-74, when the Dow Jones industrial average plummeted 45% as big growth stocks collapsed.

In that washout, the price-to-earnings ratios of Disney and McDonald’s declined to 10 and 12, respectively, from more than 70.