Some see signs that bull run has gone the distance

Times Staff Writer

Wall Street is beginning to face its primal fear: that the 5-year-old bull market may be over.

With oil prices at record highs, the dollar plunging, consumer confidence falling and no end to the housing slump in sight, the stock market has tumbled in the last few weeks.

The Dow Jones industrial average slid 211.10 points on Wednesday to 12,799.04, a seven-month low. Key blue-chip indexes now are down nearly 10% from their recent record highs, and indexes of smaller stocks are down almost 14%.

After rebounding in September and October from the August dive brought on by the financial industry’s woes, the market has been unable to hold on to its gains.


That has convinced some investment pros that stocks have begun a bear market -- meaning a decline that ultimately would slash at least 20% from major indexes such as the Dow and the Standard & Poor’s 500, as worried investors pull away.

Typically, bear markets foreshadow a troubled economy.

Tom McManus, investment strategist at Banc of America Securities in New York, believes that the stock market’s struggles in the last few months are warning of a consumer-led recession that will drag down corporate earnings in 2008.

The sharp declines this year in financial stocks and in shares of companies heavily dependent on consumer spending are “pointing the way to a more difficult economy than what is currently anticipated” by many investors, McManus said.


Most market pros don’t buy the recession view, and instead see the drop in stocks as a “correction” in a continuing bull market -- a chance to pick up shares at lower prices before they rebound.

There is widespread belief that the Federal Reserve, which has been cutting interest rates since mid-August, will continue to ease credit and that its efforts will keep the economy afloat.

“I think the Fed will ease aggressively,” said Jason Trennert, investment strategist at Strategas Research Partners in New York. Comparing the potential risk in stocks to the potential reward, “the outlook is very positive right now,” he said.

Despite the latest slide in share prices, many investors still are sitting on decent gains for the year. Of 10 major industry sectors in the S&P; 500, eight are up for the year.

The worst of the market’s pullback has been concentrated in two sectors: financial companies, which have been hammered by surging losses on mortgages, and the “consumer discretionary” sector, which includes automakers, home builders, retailers and other companies whose fortunes are tied to U.S. consumers’ ability to spend.

For many other American companies, there has been no sign that business is falling off a cliff. Tech giant Hewlett-Packard Co. this week said profit surged 26% in its fiscal quarter ended Oct. 31. Farm machinery leader Deere & Co. reported a 52% earnings jump in the same period, helped by robust foreign demand.

Still, investors in recent weeks have been dumping stocks across the board, including some that had held up well for much of the year, such as many tech issues.

Some analysts liken the situation to a game of musical chairs: Week by week, investors are finding fewer and fewer stocks in which to stay put.


Transportation-industry stocks, considered a bellwether of the economy’s trend, have been particularly weak. The Dow transports share index is down nearly 20% from its all-time high reached in mid-July.

James Stack, a veteran analyst who edits the InvesTech market newsletter in Whitefish, Mont., contends that “we have all the ingredients present for the death of the bull market.”

One classic ingredient is a credit crunch. Spooked by mortgage losses, banks and investors have become less willing to extend credit. That is choking off the flow of money in the economy.

The Fed is trying to fight that by cutting interest rates, but it isn’t clear it will succeed in time to avoid a recession, Stack said. Rate cuts in 2001 couldn’t forestall that year’s recession, he noted.

Rising inflation pressures also have historically been a major threat to bull markets. With oil nearing $100 a barrel, investors are growing more fearful of the potential inflation fallout next year -- and of the effect on consumer spending.

Market optimists such as Trennert say one factor strongly in their favor is that stock prices are relatively modest compared to companies’ per-share earnings.

The price-to-earnings ratio, or P/E, of the S&P; 500 index is about 14 based on analysts’ estimates of the companies’ 2008 earnings per share, according to Thomson Financial.

By contrast, many big-name stocks had P/Es of 20 to 30 at the peak of the bull market in 2000.


In theory, at least, the lower a stock’s P/E, the lower the risk of a steep decline in the share price.

But some investors snapped up shares of banks and home builders early this year because the stocks appeared cheap compared to earnings.

What those buyers didn’t expect was that the companies’ earnings outlooks would get far worse than was widely assumed at the time.

Some analysts say it’s a toss-up whether a bear market has begun. Bill Strazzullo, market strategist at Bell Curve Trading in Freehold, N.J., said his current forecast is for the S&P; 500 to drop another 5% or so. That would still be within the parameters of a mere correction rather than a bear market.

But he said the onus was on the bulls to come up with reasons why stocks should suddenly rebound to new highs, given the housing crisis, consumers’ sour mood and falling confidence in the dollar’s value.

“What is going to be the catalyst that’s going to drive us significantly higher here? I can’t see it,” Strazzullo said.

Even if a bear market is underway, it probably won’t rival the last one in severity, Stack said.

The 2000-2002 bear market began with the bursting of the technology-stock bubble, continued through the recession of 2001 and ended with a dramatic sell-off fueled by the accounting scandals at Enron Corp. and other big-name firms.

The S&P; 500 index fell 49% from March 2000 to October 2002. That made it one of the worst slumps of the last 100 years.

“I don’t think we’re going to see a heart-thumping decline this time,” Stack said. “I don’t see more than a 30% drop.”

But any decline could be stretched out for a year or longer, challenging investors’ patience with stocks, he said. That’s the nature of bear markets.

His advice: Investors who have the bulk of their money in stocks, and who aren’t mentally prepared to sit through deeper losses, should consider selling a portion of their holdings -- say, 10% or 20% -- and moving that into short-term cash accounts.

Bear markets don’t last forever, and “profit opportunities always come around again,” Stack said. But given mounting risks, “This isn’t the kind of market to be fully invested in,” he said.