Markets Nearing Crucial Stage
The stock market’s latest slide to five-year lows is raising new risks for the economy, government coffers and foreigners’ willingness to invest in U.S. assets.
It’s also confounding market pros--and millions of individual investors--who now are focused on trying to pinpoint the end of stocks’ long decline, in the hope of reaping huge rewards when prices finally turn.
The debate over the beleaguered market’s next move took on greater urgency last week, when blue-chip share indexes suffered their biggest one-week drop since the plunge that followed the September terrorist attacks.
By some measures, the losses since the market’s zenith in March 2000 already rank as the worst since the Great Depression. And, as stocks continue to fall, experts warn there is mounting risk of collateral damage--most significantly, to the economy, federal and state budgets, and to the inflow of badly needed foreign capital.
Economist Bill Dudley at brokerage firm Goldman Sachs & Co. in New York last week told clients he is “becoming more pessimistic about the economic outlook,” which he said “reflects mainly the weakness of the U.S. equity market.”
An index of consumer confidence last week dropped to its lowest level since November, which economists said stemmed in part from Americans’ concerns about the market’s woes. More than half of all U.S. households are believed to own equities.
On Friday, the White House Office of Management and Budget forecast a $165-billion federal deficit for fiscal 2002 and warned that “the stock market and the capital gains receipts it generates have become more important than ever to the federal budget outlook.”
The implication is that, without a market rebound, the deficit could balloon further. The same may be true in states such as California, where a collapse in capital gains taxes has helped create a $23.6-billion budget gap.
Also last week, the dollar’s value fell to a two-year low against the euro and a nine-month low against the Japanese yen, a sign that foreign investors increasingly are selling U.S. securities and taking their money elsewhere.
Because the United States continues to run a massive trade deficit, foreign capital inflows are critical. Without that money the economy could sputter for lack of investment, economists warn.
As the worries pile up, however, so too does the sense that the stock market may at last be nearing rock bottom. Historically, that has often been the case: Bear markets end when investors’ mood is at its gloomiest. And the rallies that follow usually are explosive.
But on the information-overloaded Wall Street of the 21st century, everyone knows, or thinks they know, how to measure when sentiment hits that critical point that signals it’s time to buy shares.
And that’s part of the problem: Investors, bullish and bearish, are intently watching the same technical indicators, and in so doing they may be skewing the readings of some of those indicators--further handicapping efforts to get a clear view of whether the market is ready to turn.
One well-known barometer is a weekly survey of market newsletter writers nationwide by a service known as Investors Intelligence. Historically, when the percentage of newsletter writers who are bearish on stocks exceeds the percentage who are bullish, it usually has signaled that stock-selling has reached at least a temporary peak. That was the case in late September.
Currently, bullish newsletter writers outnumber bears by 39.8% to 36.7% (the rest count themselves as relatively neutral). That astounds many analysts, given the enormousness of the market’s recent losses. It indicates a lack of fear and raises the question: Are many investors staying optimistic only because they assume everyone else is giving up?
If that’s the case, it may mean that the bottom for share prices still is far away, some say, because too few people have yet sold.
“Everyone is a market technician today,” said economist Paul Kasriel at Northern Trust Co. in Chicago. “And everyone is waiting for [other investors’] capitulation to signal it’s time to buy.”
“Everyone is watching for the same signs,” said Joe Sunderman, trading manager at Schaeffer’s Investment Research in Cincinnati. “Well, a watched pot never boils.”
Yet some market pros are telling clients that many stocks have fallen to levels where the only smart decision is to snap them up, despite the black cloud of corporate financial scandals hanging over Wall Street and the threat of more terrorist attacks.
Barton Biggs, a veteran investment strategist at brokerage Morgan Stanley in New York, who was a voice of caution during the late 1990s market surge, last week wrote an essay titled “Don’t Bet Against America.” In it, he said that “at today’s prices, I do think that investors can make money in the short run, and this is no time to be selling stocks.”
Biggs may have felt motivated to speak up when the market failed to rally after President Bush delivered his ethics lecture to corporate America last Tuesday. The Dow Jones industrial average tumbled 695 points, or 7.4%, for the week, to end Friday at 8,684.53. That was the biggest weekly decline since the Dow skidded 14.3% in the week the markets reopened following the Sept. 11 attacks.
The Nasdaq composite index, dominated by the nation’s technology giants, fell 5.2% last week to 1,373.50. Nasdaq, now at levels last seen in May 1997, has fallen 73% from its March 2000 peak, a decline that is nearing the 90% drop in major market indexes in the Depression years of 1929-32.
This week, Wall Street is hoping for encouraging words from an authority considered second only to Bush: Federal Reserve Chairman Alan Greenspan.
The Fed chief on Tuesday morning will deliver his semiannual economic report to Congress. In testimony before a Senate committee, Greenspan is expected to sound upbeat. And although he isn’t expected to offer a definitive view on whether stocks are overpriced or underpriced, he is likely to sound reassuring about the market’s long-term health and may suggest that there is a “disconnect” between the market’s slide and what is happening in the economy, analysts say.
“I see him painting the glass as half-full,” Goldman Sachs’ Dudley said.
In fact, the news in recent weeks has been far from grim. Auto sales were surprisingly strong in June, and though the national unemployment rate ticked up to 5.9% last month, average hourly wages for production workers rose--an important indicator of consumers’ ability to keep spending. Also, mortgage rates have fallen again to near all-time lows, further bolstering the robust housing market.
Perhaps most important for investors, companies are beginning to report their earnings for the quarter ended June 30, and the results overall are expected to show the first increase since the fourth quarter of 2000.
General Electric Co., a conglomerate often considered a microcosm of the U.S. economy, on Friday said that its earnings rose 14% in the second quarter from a year earlier and that profit in the current quarter could rise 25% as the economy improves. The company’s stock gained $1.25 to $28.60 on Friday after dropping to $27.05 on Wednesday, the lowest price since 1998.
Wall Street’s weakness in the face of the prospect of rebounding earnings is forcing analysts to ask whether the market might be signaling that the economic recovery soon will run out of steam.
Few economists believe the nation will slip back into recession. “Fortunately, the average person on the street, who does not own many stocks, has not been affected very much by the plunge in equity prices and continues to spend,” said Sung Won Sohn, economist at Wells Fargo & Co. in Minneapolis.
But some experts, such as Dudley, say the continuing slide in share prices might be a harbinger of an extended period of “subpar” economic growth, as the fallout spreads from the bursting of the late 1990s market bubble, perhaps the biggest in U.S. history.
“When the bubble is being created, most of the ripple effects are favorable, and these effects act to sustain and extend the boom,” Dudley said. “When the bubble bursts, all of these forces move in the opposite direction. It takes a long time for all the negative consequences associated with the bubble’s demise to become fully apparent.”
Many analysts, however, believe the stock market’s main problem is unrelated to the economy. They say stocks simply remain too high-priced relative to expected earnings, despite the plunge since 2000.
The blue-chip Standard & Poor’s 500 index has dropped nearly 40% from its peak in March 2000, yet the average stock in the index is priced at about 19 times this year’s expected earnings per share, by many Wall Street estimates. That is far above the historical average price-to-earnings ratio of about 14.
“So high were prices at the peak that they are still not cheap more than two years after the peak,” said Jim Grant, editor of Grant’s Interest Rate Observer, a well-read--and long bearish--market newsletter based in New York.
He allows that stocks might soon stage a rally, as has occurred several times over the last two years. But in an economy likely to show moderate growth at best, and given the financial scandals and terrorists threats also weighing on the market, Grant questions how any rally can have staying power unless investors believe stocks are truly cheap.
Others say investors’ collective mood will have to get substantially worse--and many more people will have to bail out of stocks--before prices can finally bottom. At least, that has been true in the worst bear markets of the past.
“I still think we’re in this environment where people think another bull market is right around the corner,” said Kevin Marder, strategist at Ladenburg Thalmann in Los Angeles. “What we need to see is more people disgusted and believing that stocks will never come back in their lifetimes.”
