Cautious Investors Halt Rally
Risk became a four-letter word again on Wall Street in March, making for a mostly losing first quarter for U.S. stocks and bonds.
Rising interest rates and another surge in oil prices turned many investors cautious last month, halting a rally that had lifted the Dow Jones industrial average to its highest level in nearly four years by March 4.
The Dow ended Thursday at 10,503.76, off 37.17 points, or 0.4%, for the day and down 2.6% for the quarter.
The broader Standard & Poor’s 500 index, which finished down less than 1 point Thursday at 1,180.59, also was off 2.6% in the first three months.
Those were modest declines compared with losses in markets that traditionally have been perceived as being higher risk.
The technology-heavy Nasdaq composite, for example, slid 8.1% in the quarter, ending Thursday at 1,999.23, down 6.44 points, or 0.3%, for the day.
The Russell 2,000 index of small-company stocks, a market star for the last two years, took a big hit as well: It’s down 5.6% year to date, the worst quarterly decline since summer 2002.
The downturn in the indexes invariably means that investors are taking their money elsewhere. Corporate junk bonds and foreign emerging-market stocks and bonds also saw defections in March.
“People are starting to pay attention to risk again,” said Brett Gallagher, head of U.S. equities for Bank Julius Baer in New York.
More-speculative markets were the place to be in 2003 and 2004, as investors’ optimism rebounded with the improving global economy. High risk then meant high returns.
But this year, stubbornly high oil prices and rising interest rates are reminding Wall Street that dicier securities also can suffer sharp and deep declines when optimism wanes.
The big question: Was the first quarter just a hiccup for markets -- or the prelude to much worse trouble? That may depend, analysts say, on the same two variables that riled investors in the last three months: oil and interest rates.
Oil futures jumped again on Thursday, rising $1.41 to $55.40 a barrel, after a Goldman Sachs analyst said prices could soar above $100 in the next two years.
A further advance in oil could deepen inflation concerns and raise doubts that the economy could continue to expand.
Inflation worries had already begun to dog the bond market in the first quarter, even before the Federal Reserve on March 22 hinted that growing price pressures might force it to begin tightening credit at a faster pace.
The 10-year Treasury note yield, a benchmark for mortgages and other long-term rates, ended at 4.48% on Thursday, down from 4.55% on Wednesday but up sharply from the first-quarter low of 3.99% on Feb. 9.
Most major bond mutual funds lost between 0.5% and 1.5% in the quarter, as the jump in interest rates devalued older fixed-rate bonds.
Investors shouldn’t underestimate the risk to the stock market posed by rising rates, said Peter Boockvar, equity strategist at Miller Tabak & Co.
“We have a lot more to fear from higher interest rates than from oil,” he said.
Today could bring a major test for markets: The government will report on job growth in March. A larger-than-expected number could spook bond investors by fueling concerns that faster economic growth would add to inflation worries.
What Wall Street wants is a Goldilocks economy: not too hot but not too cold either.
Market optimists say investors may have become too downbeat about the economy and the stock market’s prospects.
“Negative sentiment is generally a good sign for stocks, which we think are likely to rally over the next three to six months,” said Tobias Levkovich, equity strategist at Citigroup Global Markets.
First-quarter corporate profit reports, which will begin to dominate headlines in two weeks, could be crucial to restoring confidence in stocks.
Earnings of the S&P; 500 index companies are expected to rise about 8% in the first quarter, on average, according to Thomson First Call.
Leo Grohowski, chief investment officer at Deutsche Asset Management in New York, said he was betting that the final number would be closer to 10%, which could give investors comfort that the economy remains healthy, he said.
Investors have showed in recent days that they’re still receptive to encouraging earnings news. Shares of hospital giant HCA have rocketed nearly 10% since Monday, after the company said first-quarter earnings would beat expectations.
On Thursday, computer disk drive maker Western Digital leaped $1.58 to $12.75 after it too raised its quarterly outlook.
Still, if interest rates continue to rise, investors are unlikely to be in the mood to pay up for stocks, Grohowski said.
Rising rates slammed shares of many mortgage lenders in the first quarter, as well as real estate investment trust issues. Automakers slumped as investors worried about the effect of higher rates, and higher gasoline prices, on auto sales.
Stocks that sell for high price-to-earnings ratios also make investors nervous in times of rising interest rates because of the greater risk of an economic stumble. Those concerns hurt many Internet-related issues in the first quarter.
As the U.S. market struggles, some pros advise looking abroad. Foreign markets became increasingly popular with U.S. investors over the last two years, as the dollar slumped. A weak buck boosts the value of foreign shares when translated from stronger local currencies into dollars.
The dollar threw investors a curve in the first quarter, gaining against the euro, the yen and other rivals. The euro ended Thursday at $1.296, down from $1.355 at year’s end.
Yet even as the stronger dollar ate into foreign stock returns, many overseas markets performed well enough to leave U.S. investors with gains year to date.
Bank Julius Baer’s Gallagher said he was telling clients that foreign emerging markets, in particular, may offer bargains now. “We still like those longer-term,” he said.
Other strategists say the best stocks to buy on any pullbacks may be the first quarter’s U.S. leaders -- energy and other commodity-related issues.
“I think that’s where the best fundamentals are,” said Miller Tabak’s Boockvar, though he added that if he was right, that didn’t bode well for the market as a whole.
(BEGIN TEXT OF INFOBOX)
Wobbly Wall St.
Most major U.S. stock market indexes fell in the first quarter after last year’s rally. A sampling:
*--* Pctg. price change Index 2004 1st qtr. NYSE energy +25.5% +12.7% Dow utilities +25.5 +7.0 S&P; mid-cap +15.2 -0.7 NYSE composite +12.6 -1.1 Dow transports +26.3 -2.2 Dow industrials +3.2 -2.6 S&P; 500 +9.0 -2.6 Russell 2,000 +17.0 -5.6 Nasdaq composite +8.6 -8.1 Bloomberg REITs +24.8 -8.3 *--* Source: Bloomberg News
(BEGIN TEXT OF INFOBOX)
Foreign markets
Many foreign stock market indexes rose in the first quarter in local currencies, but returns in U.S. dollars were less as the buck rose.
*--* 1st qtr. change Market/index Local In dollars S. Korea/compos. +7.8% +9.9% France/CAC +6.5 +1.9 Canada/TSX +4.0 +3.2 Germany/DAX +2.2 -2.2 Britain/FTSE 100 +1.7 +0.3 Japan/Nikkei +1.6 -2.9 Brazil/Bovespa +1.6 +0.7 Australian/ASX +1.5 +0.3 Mexico/IPC -1.9 -2.0 Hong Kong -5.0 -5.3 *--* Source: Bloomberg News
(BEGIN TEXT OF INFOBOX)
Industry group winners and losers
Here are the 10 best-performing and the 10 worst-performing stock industry groups within the blue-chip Standard & Poor’s 500 index in the first quarter:
Best performers *--* Oil/gas exploration +24.8% Oil/gas refining/marketing +24.1 Healthcare facilities +22.6 Oil/gas drilling +17.6 Integrated oil/gas firms +16.5 Fertilizer/agrochemicals +16.1 Drugstore chains +16.1 Distillers and vintners +12.5 Department store chains +12.1 Personal products +11.3 *--*
Worst performers
*--* Computer storage/peripherals -13.6% Thrifts/mortgage finance -14.0 Airlines -15.0 Casinos/gaming -15.1 Home entertainment software -16.1 Electronic manufacturing svcs. -18.0 Automakers -24.5 Auto parts/equipment -24.8 Information tech. consulting -30.7 Internet retailing -35.9 *--* Source: Bloomberg News
