BUSINESSWEEK ONLINE : NOVEMBER 27, 2000 ISSUE
COVER STORY Can the Market Regain Its Balance? Investors will likely face more volatility and downward drift, even after the political dust settles While the country remains sharply divided over the election, there's one thing pretty much everyone agrees on: investing in stocks has become a more perilous pursuit. Since Election Day, the tech-laden Nasdaq has tanked 7%. On Nov. 13, it closed under 3000 for the first time in over a year. The Dow Jones industrial average is down 2%, the Standard & Poor's 500-stock index 3%. And with less than two months before yearend, the likelihood that indexes will finish with a gain is vanishing fast. In sharp contrast to a handful of Wall Street strategists who call this a buying opportunity, most say the market could get worse before it gets better. Even when the punch-ballot chads settle, there are key factors that will likely cause continued volatility and a drift toward the downside. The outlook for 2001 is better, considering that the Nasdaq has already had most of the steam taken out of it and price-earnings ratios have come back to earth. Still, the market will probably harken back to a more normal era when returns were in the single digits. And the fact that there is no mandate for the next President and there is a narrow split between congressional Republicans and Democrats could be a plus for the market next year. Neither side will be able to push through extreme proposals for big tax cuts or excessive spending. But right now, it's the economy that matters most. ''Politics is an interesting sideshow, but once this is over it will all come down to the velocity of the economy--its slowing and effect on profits,'' says Thomas Galvin, chief equity strategist at Credit Suisse First Boston. Fourth-quarter earnings pre-announcements, where companies disclose any material information that may affect the price of their stock, have started to come in at unprecedented levels. So far, 243 companies have issued preannouncements (and no one on Wall Street has asked for a recount). That's compared with a total of only 233 for the entire fourth quarter a year ago. Of these, 59.7% have been negative, according to earnings research firm I/B/E/S Inc. BestBuy ( BBY), Sprint ( FON), WorldCom ( WCOM), Priceline.com ( PCLN), and Altera ( ALTR) are just a few that have recently issued negative preannouncements. The bigger story may be in earnings revisions. Analysts continue to slash earnings estimates for the fourth quarter and the first quarter of 2001. For the fourth quarter, estimates are projected to come in at 11.2% over last year's same quarter. That's down from an estimate of some 15.6% a little more than a month ago. For all of 2001, analysts predict earnings will grow only 12.6%, compared with a projected 19.1% for 2000, according to First Call. Even Charles Hill, First Call Corp.'s director of research, concedes that may be overly optimistic and that growth may end up in single digits. A shortfall in tech earnings is affecting the market the most. ''As earnings prospects for the tech sector are revised downward, that creates substantial valuation-related issues, which tend to exacerbate the selling pressure,'' says Tom Marsico of Marsico Capital Management. With earnings in question, strategists say that any stock rally before yearend is likely to be shortlived. ''It would be derailed by proliferating negative preannouncements and the actual earnings season, when more shoes will drop,'' says Douglas Cliggott, U.S. equities strategist at J.P. Morgan & Co. Don't expect the Federal Reserve to help matters. The Fed decided on Nov. 15 to leave interest rates and its anti-inflation bias unchanged, so the market won't get any boost from Chairman Alan Greenspan, though the Fed's stance does increase the likelihood of a continued soft landing. In fact, even if the Fed does eventually change its bias to ''neutral,'' some say that won't be enough to set the stage for a raging comeback, as other negatives, like the highest oil prices in a decade and a weak euro, continue to hurt the economy. ''In a tightening cycle when things start to perform poorly, you have to cut rates not just once, but twice, to get any real effect in stocks,'' says Tim Hayes, global equity strategist at Ned Davis Research Inc. in Venice, Fla. History is also not on the side of the bulls. In the four-year election cycle, post-election years tend to show the weakest gains of all. And although there is often a post-election rally, this year is an anomaly. ''We usually have a Presidential honeymoon after the election, but this may be one of those years when there's no honeymoon because you don't know how legal the marriage is,'' says Robert Stovall, market strategist at Prudential Securities Inc. Meanwhile, investors can't get their minds off the current election mayhem. While the polls may show that the public isn't necessarily in a hurry to have the election resolved, the stock market is considerably less patient. ''If there's anything the market hates, it's uncertainty,'' says Credit Suisse First Boston's Galvin. "PERFECT ENVIRONMENT." Some pros are saying this is a buying opportunity. ''Political uncertainty does not negate the fact that the investment environment remains perfect--with low inflation, continued profit growth, and a budget surplus,'' says Edward Kerschner, chief global strategist for UBS Warburg and PaineWebber. And Goldman Sachs & Co.'s strategist Abby Joseph Cohen contends that equity valuations are the ''most attractive they have been all year.'' She says the S&P 500 is about 15% undervalued on a 12-month view. Another good sign for the market that is often overlooked: Individual investors tend to increasingly buy and hold their stocks for the long run. According to a recent survey of 600 investors by the American Association of Individual Investors, their average asset allocation--71% in stocks, 9% in bonds, and 20% in cash--has not shifted significantly in over two years. Even so, bad news of any sort is sending stocks south as fast as Sunbelt snowbirds in late autumn. Institutional investors are now quickly dumping their positions in any tainted stock or sector. On Nov. 13, Hewlett-Packard Co. ( HWP) stunned the market with an earnings shortfall that sparked the Nasdaq to tumble as much as 5.6% during the day (page 59) as investors questioned the technology sector's growth rate. Other companies like Morgan Stanley Dean Witter ( MWD) and Nortel Networks Corp. ( NT) have reported similar shortfalls that have clobbered their respective sectors. ''One company misses any of their presumed objectives and it shakes confidence in the whole sector. And when it's a tech stock, it hurts the entire market,'' says Prudential's Stovall. The Presidential pandemonium is scaring off foreign investors, say experts. In the futures pits at the Chicago Mercantile Exchange, foreign investors are making ''Sell America'' trades, where they wager that U.S. stock and bond markets will falter because of the political uncertainty. ''There's a major repatriation of funds back to Europe. One investor told me that it's disappointing when the U.S. election process is less solid than in Yugoslavia,'' says Laszlo Birinyi, president of Birinyi Associates Inc. Asian investors have been spooked, too. ''When you invest in a country you also invest in its leader,'' says Ray Weng, president of the Chinese Securities Assn. Weng has already pulled some money out of U.S. holdings. Some say skittishness on behalf of foreigners is particularly worrisome since overseas investment in U.S. equities has added to the market's oomph in recent years. According to the Federal Reserve, foreigners own $1.6 trillion, or some 8.3% of all U.S. securities. And some 80% of the net savings in the world is invested in the U.S., say economists. Says William H. Gross, managing director at Pacific Investment Management Co.: ''Foreign investors might simply feel better keeping money close to home.'' "FORGET AMAZON." And although U.S. investors may have stronger stomachs than their foreign counterparts right now, many are simply waiting it out or putting new money into fixed-income. ''Forget Amazon ( AMZN). And anyone who owns AT&T ( T) or Lucent ( LU) thinks 7% on a certificate of deposit is an attractive investment now,'' says Joel P. Bruckenstein, a financial planner with Global Financial Advisors Inc. Bruckenstein also likes ''safer and overlooked'' value stocks. While the S&P 500's technology sector has declined 40% from its March peak, classically defensive stocks in areas like health care, consumer staples, and utilities have posted positive returns from nearly 12% to more than 33%. ''Beaten-down companies that have more market share, better pricing power, and no debt are going to be the winners,'' says Bruckenstein. He likes home builders like Fleetwood Enterprises Inc. ( FLE) and retailers like Federated Department Stores ( FD). It's unlikely that the technology sector will suddenly come roaring back, say analysts. ''There's a generational change taking place in tech. The leaders of the past decade--PC stocks, database stocks, cellular stocks--are unlikely to be the leaders of the next big wave,'' says Roger McNamee, founding partner of Integral Capital Partners in Menlo Park, Calif. And with 70% or more of the market capitalization in old-guard tech stocks like Microsoft ( MSFT), Intel ( INTC), and Dell Computer ( DELL), says McNamee, it will be difficult for tech stocks in the aggregate to remain market leaders in the next two to three years. Even financial stocks, which have gained 15% for the year, may be starting to slump. Earnings at brokerages are predicted to grow by only 9% in 2001, compared with a 28% rise this year, according to First Call. ''We're taking a more subdued view than six months ago or even a few weeks ago,'' says Henry McVey, securities industry analyst at Morgan Stanley Dean Witter. McVey recommends financial services outfits like Merrill Lynch & Co. ( MER) and Citigroup ( C) that are diversified enough to grow despite slowing underwriting fees and brokerage commissions. That's not stopping some from buying beaten-down techs and financials. ''We've recently bought companies like Micron Technology ( MU), Siebel Systems ( SEBL), and Altera,'' says Timothy Ghriskey, senior portfolio manager at Dreyfus Corp. But just because a stock has been pummeled doesn't make it a good buy. ''This is an environment where knowing companies inside and out in order to accurately assess their earnings potential is critical,'' says Robert Stansky, manager of the Fidelity Magellan Fund. Once the Presidency is decided, no doubt investors will also be tempted to pick up ''Bush'' stocks in areas like energy, pharmaceuticals, aerospace and defense or, conversely, ''Gore'' stocks in areas like agriculture, the environment, and technology. But don't expect those to rally much. ''Given the circumstances, it's not a mandate for either party to make sea changes in fiscal policy or anything else, and that's good for the market,'' says Nick Sargen, global market strategist at J.P. Morgan. That may be the only good thing that has come out of this election mayhem. By Marcia Vickers in New York, with Mara Der Hovanesian, Debra Sparks, Emily Thornton, Heather Timmons and bureau reports _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP					RELATED ITEMS The Economy: Passing a Dimmer Torch COVER IMAGE: The New President's Economy CHART: Growth Slows...As Tech Demand Weakens...Manufacturing Dips... CHART: ...The Stock Market Declines...The Trade Gap Explodes...And Corporate Debt Surges TABLE: Turbulence Ahead The Alan Greenspan of OPEC? CHART: Fill 'Er Up Can the Market Regain Its Balance? CHART: Scaling Back Expectations CHART: Losing the Investor Vote TABLE: The View from Four Wall Street Gurus Commentary: The Pitfalls of One Person, One Vote TABLE: Where the Votes Are TABLE: No Electoral College Sleight of Hand at the Polls TABLE: Tricks of the Trade Is There Any Help for the ``Hanging Chad''? Commentary: The Young and the (Still) Listless INTERACT E-Mail to Business Week Online

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