Losing Week Fuels Doubts on Recovery
Some investors are wondering if Christmas already has come and gone on Wall Street.
Last week brought an end to the Dow Jones industrial average’s eight-week winning streak and marked only the second losing week for the Standard & Poor’s 500 index since early October.
A pullback after a strong rally can be expected, analysts said. But this drop, accompanied by recent mixed readings on the U.S. economy, raises doubts about whether the 2 1/2-year-old bear market is ready for a robust reversal.
“The stock market has gotten a little ahead of itself,” said Alan Adelman, chief investment strategist at Wells Fargo & Co.’s private client services in Los Angeles.
“Investors are going to demand more evidence that an economic recovery is underway before sending stocks higher.”
The Dow, which rallied 1,645 points from its six-year closing low Oct. 9 through its recent high Nov. 27, has backed away sharply from that peak. At its intra-day low Friday -- before Treasury Secretary Paul H. O’Neill and White House economic advisor Lawrence B. Lindsey tendered their resignations -- the index had given up one-fourth of its October-November rally.
The comeback had been fueled by economic reports pointing to stability and modest, if unspectacular, growth. But in the last week, the various data have sent conflicting signals. Strong productivity numbers early in the week, for example, were followed Friday by the Labor Department’s report on November unemployment, which surged to a higher-than-expected 6%.
Though Adelman remains guardedly optimistic that the market reached a meaningful low in early October, he said the spike in joblessness raises the risk that nervous consumers might curtail their spending -- an unsettling prospect for the economy.
Overall, corporate profits appear to be gradually improving, said Chuck Hill, research director at earnings tracker Thomson First Call in Boston.
However, it’s still early in the fourth-quarter “confession season,” when companies come clean with analysts and investors by revising their earlier earnings guidance for the period. More clues about the near-term trend could emerge this week as more companies release profit outlooks. Thomson First Call expects S&P; 500 earnings to grow 15% in the quarter compared with last year.
Many of the companies that have issued warnings so far -- such as Walt Disney Co., which appears to have a mega-flop on its hands with the animated film “Treasure Planet” -- face specific problems that have little broad economic effect, Hill said.
The problem for the stock market, he added, is that business fundamentals remain shaky in technology and telecommunications.
Those sectors paced the October-November rally, but the surge made tech and telecom stocks a lot more expensive just as their business prospects became murkier.
Some in the sector, such as chip makers Intel Corp. and Advanced Micro Devices Inc., say their fourth-quarter sales will be strong. But looking further out, other tech companies, such as Hewlett-Packard Co., have given downward guidance on revenue estimates for 2003.
“The tech companies may be on track to hit their bottom-line numbers, but they’re doing it through cost-cutting rather than sales growth. That’s not encouraging,” Hill said, because sales growth is seen as essential to a healthy earnings trend.
Hopes for a pickup in business capital spending have been pushed back to the third quarter of 2003 at the earliest, sending tech profit forecasts into a free fall.
Estimates for overall S&P; 500 earnings growth in the first quarter, for instance, have been ratcheted down to 12.3% from earlier estimates of 25.3%. But profit growth estimates for the tech stocks in the S&P; 500 have contracted more dramatically, to 15% from 60%.
Tech’s troubles raise two issues for the market, Hill said. First, they may signal that the economic recovery is “further away than anybody realizes.”
Second, investors rushing back into the sector could be setting themselves up for a nasty tailspin, just as they did in the late 1990s and early 2000. In a downturn, volatile and steeply valued stocks often are hardest hit. Indeed, the tech-laden Nasdaq composite index has fallen 4.4% during the recent sell-off, compared with a loss of 2.8% for the S&P; 500.
With U.N. weapons inspectors on the ground in Baghdad, fears of a U.S.-Iraq war also weigh heavily on investors and on the economy, analysts say.
“The market has been suffering from Iraq-aphobia, but I think the likelihood is that a conflict would not be as bad as many people fear,” said Richard DeKaser, chief economist at National City Corp. in Cleveland.
For instance, DeKaser said he didn’t see oil surging above $40 a barrel, as some have warned, given the recent buildup in U.S. and European reserves and the likelihood that members of the Organization of the Petroleum Exporting Countries would ensure supply.
By late winter or early spring, he said, the conflict could be settled, which would probably put U.S. businesses in more of a spending mood.
Friday’s White House shake-up also could have a positive effect on the market, analysts said, because O’Neill was seen as a potential impediment to tax cuts and other fiscal stimulus measures.
“We’ve had a lot of monetary stimulus from the Federal Reserve cutting interest rates,” Adelman said, noting that the Fed has slashed its benchmark interest rate to a four-decade low of 1.25%.
“What was missing was fiscal stimulus, and now we’re going to get some.”
One proposal that could give investors and the economy a boost, he said, is the elimination of “double taxation” on dividends, which are taxed as income when corporations record profit, then taxed again if distributed to shareholders in dividend form.
Such a move could send dividend yields, already on the rise, still higher, making stocks more attractive to investors.
A separate proposal to increase the amount of realized capital losses that can be written off against income -- currently $3,000 -- could boost consumer spending as well, Adelman said.
The Fed, which cut its benchmark interest rate by half of a point at its Nov. 6 meeting, isn’t likely to notch the rate any lower when it gathers Tuesday, analysts say.
