Uncertainty Raised as Stocks Sputter
Are stocks just taking a breather -- or did yet another “bear market rally” just take its last breath?
After four weeks of strong gains, the major U.S. market indexes hit a wall last week, with the Standard & Poor’s 500 and the Nasdaq composite retreating 0.7% and 0.1%, respectively, while the Dow Jones industrial average eked out a 0.2% gain to close Friday at 8,537.13.
Stocks cooled Thursday and Friday even though the Republicans regained control of the Senate in Tuesday’s elections, and despite the Federal Reserve surprising Wall Street on Wednesday with a half-point cut in its key short-term interest rate, to a 41-year low of 1.25%.
With the Dow up 20.4% from its five-year low reached Oct. 9 through Wednesday, some investors may have become jittery in the aftermath of the Fed’s decision: Might policymakers know something investors didn’t know about the economy -- something troubling?
“People are still trying to figure out whether this is just another bear market rally, or finally the beginning of the recovery phase,” said Subodh Kumar, strategist at CIBC World Markets in New York.
Several strong rallies have quickly sputtered during the bear market of the last 2 1/2 years, most recently the five-week advance during July and early August, which gave way to another plunge in September and early October.
Still, many strategists are guardedly optimistic that the market has finally bottomed and that 2003 could be a pleasant surprise. They say stocks will get a lift from lower interest rates, the Republican victory and corporate earnings that are recovering, though gradually.
Along with economic questions, however, uncertainty over possible war with Iraq could thwart or limit any further advance, strategists say.
Although earnings are far from robust and many companies, such as networking giant Cisco Systems Inc., have warned that the outlook remains shaky, overall profits continue to rebound after the deep decline of 2001, according to data tracker Thomson First Call of Boston.
With 90% of the S&P; 500 companies having reported third-quarter results, First Call said operating earnings were up 6.8% from a year earlier.
Companies have beaten analysts’ expectations by 2.4 percentage points, on average, though that partly reflects managements’ success in previously guiding down Wall Street’s estimates for the quarter. The performance also reflects the easy comparisons with depressed 2001 profits.
For the fourth quarter, analysts’ profit projections also have been declining, but they still expect 16.7% growth for the S&P; 500 companies overall, according to First Call.
For all of 2003, analysts now expect S&P; 500 earnings to rise 14.9% from 2002. That estimate has fallen from 17.8% as of Oct. 1.
Though growth expectations may have to be lowered, some recent developments could help bolster results, experts say.
For example, profits of U.S. multinational companies could get a boost from renewed weakness in the dollar, said Robert Nichols, chairman of Windward Capital Management in Los Angeles.
The euro currency rose to $1.01 on Friday, up from 97 cents in mid-October and the highest level since early 2000. The rising euro should help U.S. firms in Europe when revenue there is translated back into dollars.
Perhaps most significantly, the election and the Fed’s latest rate cut are likely to benefit stocks in the near term, Nichols said.
With Republicans back in control of the Senate, they may be able to get an economic-stimulus package through Congress that lowers capital gains taxes, eliminates or reduces the double taxation of dividends and offers businesses tax credits for capital spending and hiring new employees, he said.
“It’s the kind of thing that worked wonders for the economy in the mid-1980s,” Nichols said.
Eliminating the double taxation of dividend income could have an enormous effect, he said. After-tax money that companies distribute to shareholders in the form of dividends now is taxed as ordinary income.
Eliminating or reducing income taxes on dividends could make stocks much more appealing to investors. It also could encourage more companies to pay out more of their profit to shareholders as dividends.
“Can you imagine the pressure that would be exerted on these arrogant managements whose attitude is, ‘We can manage this money better than you can’?” Nichols said. “Shareholders would be rewarded.”
As for the interest rate picture, the Fed’s move last week will drive short-term savings rates to new generational lows. That could put more pressure on investors in search of higher returns to allocate cash savings to stocks or bonds.
The average seven-day yield on money market mutual funds, now 1.2%, is expected to drop to about 0.7% over the next six weeks, tracking the Fed’s cut.
If even a modest portion of the $2 trillion-plus in money market funds were to move into the stock market, it could have a big effect on share prices, some analysts said.
Historical trends also are in the stock market’s favor, said Jeffrey Hirsch, editor of the Stock Trader’s Almanac in Old Tappan, N.J. For one thing, stocks have entered what is often their sweet spot, November through April.
As for 2003, history says stocks tend to fare well during periods of unified GOP control of Washington, Hirsch said.
Also, the third year of any presidency is often the best for stocks. Since 1929, the Dow has risen an average of 12.9% in the third presidential year, versus 4.2% in the first, 5.2% in the second and 5.5% in the fourth, Hirsch said.
The third-year performance usually has been attributed to the sitting president’s efforts to boost the economy as he prepares to run for the White House again.
