FEBRUARY 28, 2001
SPECIAL REPORT
Finding Your Feet after Topsy-Turvy Times | Bad economic news is bad for stocks again, and good news (if you can find any) is good. But what news is really important?
| The bull is finally beaten. It took almost 12 months -- the Nasdaq slide began last March -- but in the last days of February, the Standard & Poor's 500-stock index dropped a full 20% year-to-year. That's the official definition of a bear market. To anyone who has been invested in the 50%-lower Nasdaq over the past year, a 20% drop sounds almost like a reprieve. But the fact that the S&P 500 is now in certifiably bear territory shows that we're living through more than just a correction in an inflated tech sector.
Investors sure took their time recognizing the signs of a significantly slowing economy. Some of the blame can be laid at the door of certain fallacies that entered the canon of conventional wisdom about the New Economy. First and foremost: The tech sector is immune to business cycles. Then there was the newfangled bromide about layoffs: They're bad? No, they're good, because they reflect increased productivity generated by new technology, and the laid-off workers would soon find new jobs anyway.
So investors should reward companies that cut workers, even if their fundamentals are shaky, the thinking went -- and that's just what happened. A similar tunnel vision developed with respect to unemployment statistics: Lower unemployment is good, right? It is to anyone who needs a job, but not according to Fed Chairman Alan Greenspan. It's bad, because it could create inflationary wage pressures.
OLD EQUATIONS. Nowadays, these topsy-turvy notions have turned 180 degrees. We've come back to a more understandable world in which bad news isn't good news anymore. Layoffs hurt consumer confidence and don't cause stock prices to jump. Marginally higher unemployment is beginning to curb consumer spending.
But now that some of the old equations appear to hold true again, it would be a mistake to get doctrinaire in how we interpret events. It may be that with all the data available, it has just become harder for the market to sort through which news really counts the most and decide what to do about it. You can't reduce your economic or market outlook to a few simple sentences anymore.
One factor that has complicated the relationship between the market and the overall economy is the sheer size of the stock market. Half of all households in America now own stock, either outright or through a mutual fund. For the past few years, these investors have been letting the stock market do their saving for them. This, in turn, has decreased the savings they take from their regular disposable income and fueled more consumer spending.
"A 10% movement in the stock market is four times more powerful in moving people's wealth position than it was 10 years ago," says Ethan Harris, chief U.S. economist at Lehman Brothers. "The stock market is now as important as interest rates to individuals' wealth."
CONCERN OR CELEBRATION? Nobody has been more conscious of this phenomenon than Greenspan. More than any other recent Fed chief, he has talked about what's going on in the stock market as relevant to monetary policy. As Wall Street's and the Fed's actions have become more closely intertwined, it has become harder to gauge the effect of economic news on the market. "In the old days, bad economic news was read as bad for earnings," says Harris. "Nowadays, you worry about whether it's cause for concern on the earnings front or cause for celebration of a Fed easing."
That explains a certain disconnect between the stock market and the economic turmoil that began last summer. The market rallied on the news that the Fed had reached the end of its tightening bias. But it ignored the fact that the Fed stopped tightening because it was getting the economic slowdown it wanted. That was bound to translate into slower earnings.
But faith in the New Economy and the soaring stock market of 1997-99 made investors reluctant to abandon equities. Never mind that bond returns of 8% overall last year blew returns on the Nasdaq, S&P 500, and Dow Jones industrial average to smithereens. "Many individual investors cut their teeth in the equity markets," says Marci Rossell, chief economist at Oppenheimer Funds. "And equities have delivered the long-term performance." Even with the dismal experience of 2000 behind them, it has been hard for individuals to give up the equity habit. "The average guy who is putting $100 a month in his investing portfolio does not move his money between equity and bonds," Rossell adds.
"PETRIFIED." Still, many investors have at least parked their money on the sidelines as they puzzle over what to do next. Money-market funds have swelled to an all-time high of $1.9 trillion, according to Tracy Eichler, investment strategist at PaineWebber. "I think investors are petrified," she says. And Eichler has seen it firsthand: "My dry cleaner sold everything because he couldn't take it anymore. He couldn't bear to look at Texas Instruments [dropping] for one more day."
This brings us to another good news/bad news conundrum: Is the current bear market a cause for flight? Or are we seeing the stock market equivalent of a post-Thanksgiving markdown as the Christmas shopping season begins? "This is a buying opportunity," says Oppenheimer's Rossell. "We are not in a long-term bear market."
Some intriguing technical statistics support this view. "The market is as cheap as it has been in the last 20 years," says Eichler. Historically, it has taken an average of four and a quarter months for a bear market to bottom, which would mean this bear, which began to prowl in December, should bottom in mid-April, according to Eichler.
A W OR A V? But not everybody is so sanguine. "We're probably going to have four or five more months of weak economic data and weak earnings for at least that long," says Lehman's Harris. "In the short term, we're not expecting a V [a sharp recovery once the market bottoms], it'll be more like a W. You'll see a lot of choppiness." That's because the market will rally on additional Fed action, according to Harris.
Unfortunately for investors, Fed moves take at least nine months to really flow through the economy. So it's going to be a while yet before we reach the hot-growth levels where Fed easing becomes bad news and Fed tightening becomes good news again. In the meantime, the strong of stomach may just want to go on a shopping spree.
By Margaret Popper in New York
Edited by Douglas Harbrecht
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Copyright 2001, Bloomberg L.P.
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