MARKET JITTERSIs the bear at the door? Probably not. Odds are this is a healthy correction
A swift-kick correction? Or an ugly bear market? The U.S. stock market has soared for nearly six years without either, defying the laws of financial gravity. But suddenly, the nose of this rocketlike market seems to be pointing almost straight at the ground. In the first two weeks of July, the Dow Jones industrial average shed 344 points, or 6%. The NASDAQ composite index, the most widely followed index of over-the-counter stocks, plunged nearly 11% in the same period. While the selling pressure seemed to abate on July 16 and 17--the Dow pulled out of a 168-point loss, rallied to a small gain by the close on July 16, and picked up 18 points on July 17--many investors and analysts believe they haven't seen the last of the wild gyrations.
There's a good reason for the sell-off. Investors are getting sharply conflicting signals. The strong employment numbers that hit in the midst of the four-day Independence Day weekend raised fears of higher inflation and interest-rate hikes. The following week, bad earnings news from technology market leaders such as Motorola Inc. and Hewlett-Packard Co. suggested that earnings were slowing sharply (page 28). The fear, says Edward P. Nicoski, market strategist at Piper Jaffray Inc., is that ``you could end up with the worst of both worlds--higher inflation and lower earnings.''
Thanks to that one-two punch, investor talk turned from an economy that was so strong it could trigger inflation to one so fragile it was about to slide into recession. ``In just a week, we've gone from a period in which every piece of news is interpreted bullishly to one in which everything is interpreted negatively,'' says Byron R. Wien, Morgan Stanley & Co.'s U.S. investment strategist, who turned bearish in May. Indeed, many commentators now have little good to say about stocks at all. ``If I had to draw a list of the positive and negatives on stocks,'' says Benjamin Zacks of Zacks Investment Research, ``I couldn't think of anything to put in the plus column.'' The volatility also roiled international markets, several of which dropped 3% or more in sympathy.
Still, for all the turmoil, the odds are that this is a correction and not the beginning of a bear market. To start with, earnings are still coming in strong, with positive ones beating negative surprises by about two to one. Good profit reports are coming from a range of blue chips such as Caterpillar, General Electric, Ford Motor, and Philip Morris. Even the battered tech sector has some bullish bright spots, including Intel and Computer Associates (page 30).
Even more important, the underlying economy is still sturdy. True, economic growth is slowing, but it should still remain above 2% in the second half of the year. Although wages are moving up after being dormant for five years, inflation remains under 3%. Employment growth is strong, and the jobless rate, at 5.3%, is the lowest in six years.
FACT OF LIFE. Perhaps even more amazing is that the White House is now expecting the U.S. budget deficit to come in this year at $117 billion, a 15-year low. That's also 1.6% of gross domestic product, the deficit's smallest share of the economy since 1974 and the lowest of all the major industrial nations. ``There's just no reason for a bear market,'' says mutual-fund manager David D. Alger of Fred Alger Management Inc.
Corrections, quite simply, are just a fact of market life: a few steps forward, one step back. The problem is many investors--especially those new to the market--have forgotten that. Since 1990, a year during which Dow Jones industrials dropped over 20%, all of the pullbacks have been under 10%.
Actually, a correction now could obviate the need for one of the things that has concerned investors most: the chance that an overly strong economy would result in a tighter monetary policy. Federal Reserve Chairman Alan Greenspan appears to have put off a decision on an interest-rate hike until August. But if the chill running through the stock market makes consumers and business more cautious, the Fed may be able to avoid raising rates altogether. ``The market correction could slow the economy, which is just what the Fed wanted,'' says John E. Silvia, chief economist at Kemper Zurich Investments.
All in all, a correction of moderate proportions--perhaps 7% to 10%--wouldn't be so bad. In fact, such drops are called corrections because they wash out speculative excesses that build up in a bull market. And this stock market, up nearly 60% in the last 20 months alone, has had more than its share of froth. Look at the high-flying technology sector, where until recently, newly public companies such as Prism Solutions Inc. and Red Brick Systems Inc., both in the red-hot data warehousing business, have traded at prices that were several hundred times projected earnings. Both are now down 60% from their highs.
GROWTH ENGINES. How this market slide plays out will have major consequences far beyond the ups and downs of the Dow. High stock prices have given Corporate America access to cheap capital that's feeding an investment and acquisition boom. The bull market has also given small companies, the engines of U.S. job growth, the ability to sell stock to the public and obtain the funds they need to grow. Over the past two weeks, though, dozens of companies, including a high-tech investment bank, Hambrecht & Quist Group, and a high-tech publishing operation, Wired Ventures Inc., have put their plans for initial public offerings on ice.
If the IPO market shuts down, some companies that are still private, such as Boulder (Colo.)-based Wild Oats Markets Inc., which was hoping to go public before yearend, may have to change their plans. ``Maybe this will only affect high tech,'' says Michael C. Gilliland, CEO of the health-food retailer. ``But we're keeping our options open. We're looking at debt financing and private money as well.'' Christopher R. Hassett, CEO and president of PointCast Inc., which develops software that allows users to get customized information and news from the Internet, is in close touch with his investment bankers, carefully tracking the course of high-tech stocks and trying to determine how it will affect his company.
On Main Street as well, the health of the market is no small matter. During the climb, millions of individuals have staked their retirements and their kids' educations on equity investments, mainly through direct purchases of stocks, mutual funds, and their 401(k) plans at work. In the past 18 months alone, the public poured some $200 billion into equity mutual funds, making them the principal source of cash for the bull market. If those investors pull out, the consequences for the market could be dire.
In fact, many investment pros are more worried about the reaction of individual investors to the market's moves than they are about any earnings report or rate forecast. ``That's what's on everyone's mind,'' says Abby Joseph Cohen, investment strategist at Goldman, Sachs & Co., of her institutional investor clients. ``Their big concern is what happens if individual investors stop buying, or worse, if they start to redeem their mutual-fund shares.''
If individuals start pulling out en masse, fund managers would have to start dumping stocks just to meet redemptions, which in turn would cause prices to go down, triggering a deadly spiral of falling stock prices. At Charles Schwab & Co., net redemptions amounted to $700 million on July 16, almost certainly a record. Domestic equity funds took the brunt of the redemption activity. But fund managers--especially those of the most aggressive, risk-taking funds--have been building reserves as a bulwark against that scenario. ``I talked to 50 fund managers in the last day, and they're all ready with cash for redemptions,'' says market-timer Douglas Fabian, who gave a sell signal to his newsletter subscribers on July 15. Fabian says investors with $1 billion in assets follow his buy and sell signals.
Indeed, for now, most investors seem to be sitting tight. The net asset value of the hard-charging PBHG Growth Fund, which buys growth stocks with high price-earnings ratios, is down 21% since late May, but investors are not bolting. The total outflow from the $6.5 billion PBHG fund family hovered around $20 million a day on July 12 and July 15, according to Gary L. Pilgrim, the fund's manager. And Pilgrim says he had amassed $750 million in cash anyway in anticipation of the earnings reporting season--so he's got plenty on hand if investors want to bail out.
SILENT PHONES. Many brokers say their phones have been surprisingly quiet. ``I have maybe 300 clients, and I've had three calls today,'' says Christopher Getman, a first vice-president at Merrill Lynch & Co. in New Haven. So far, individual investors are approaching the sell-off with a wait-and-see attitude. Robert J. Fendell, 70, a retired public-relations manager in Jacksonville, Fla., hasn't called his broker yet, but he's keeping up with the market via cable TV and will give it a few more days to see what course it takes. ``I can't afford a catastrophic loss,'' he says. If the situation is still bleak, ``I'm going to go for safer ground.''
But numerous individual investors say they just plan to wait out the pullback like a nasty summer storm. ``I'm a little jittery,'' says John O'Neil, 30, of Arlington Heights, Ill., a manager of real estate valuation in the Cook County Assessor's Office. ``But I'm in it for the long term, and I didn't consider selling anything''--even his aggressive tech mutual funds. And for some, the correction could play right into their hands. Retired dentist Herbert I. Chauser, 76, of Miami, says he was planning to shift a bigger chunk of his portfolio from bonds to stocks anyway--and may now get a chance to do so at lower prices.
Chauser may do well to look for bargains abroad, as well. Wall Street's travails have been echoed on foreign bourses, with Frankfurt, for one, falling more than 3% on July 16 and giving up about a quarter of its gain this year as Wall Street teetered on the brink of a 160-point rout. ``We all know that when the Dow has a major hiccup, it'll be felt in other markets,'' notes Mark Richardson, chief investment officer at Chase Asset Management. The Swiss and Italian markets were hit hard, too. The Mexican bolsa, still trying to recover from the peso funk, took a 3% hit on July 15.
Foreigners are also major investors in the U.S. market, though, and trying to catch the dollar's strengthening, they have come to Wall Street in droves. Should the market stumble badly, investors such as Klaus Kaldemorgen, head of international equities at DWS, the mutual-fund arm of Deutsche Bank, could bolt. ``We don't yet feel forced to sell,'' he says. Instead, he has been upgrading his portfolio, adding stronger stocks such as Citicorp, Intel, Federal National Mortgage, and Philip Morris.
Indeed, it's tough to dodge a correction, and many investment advisers recommend that investors go bargain-hunting. Lehman Brothers strategist Jeffrey M. Applegate sees good buys among banks and other financial stocks, which continue to knock out strong earnings gains even in the face of higher rates--among them Chase Manhattan, NationsBank, and J.P. Morgan. Says Applegate: ``We're seeing double-digit earnings growth, double-digit dividend growth, and single-digit p-e ratios.''
Of course, bargain hunters have some time to do their shopping. The market is likely to remain volatile into early August as earnings reports trickle in. It will also take time for the interest-rate picture to become a little clearer: If a Fed rate hike comes, it will likely do so in August--or not until after the election. Now is not the time to bail out. There is nothing on the horizon to suggest that this correction will be anything but that.
By Jeffrey M. Laderman in New York, with bureau reports
Updated June 14, 1997 by bwwebmaster
Copyright 1996, Bloomberg L.P.