FEBRUARY 28, 2001
STREET WISE
By Sam Jaffe
This Bear Isn't Ready for Hibernation | Think the market has about hit bottom? Three indicators suggest the worst is yet to come
| So we're now officially in a bear market. Unless you've been lost in the desert for the past year, you know that the stock market has been in a steady downward spiral. And on Feb. 23, everyone from CNN and CNBC to USA Today and Bloomberg Radio broadcast the news that the Standard & Poor's 500-stock index was officially down 20% from its 52-week high of 1553 in March, 2000.
So, what now? Put all your money in a bear market fund? No way. An unfortunate axiom of market forecasting is that once you're able to prove something may be coming, it's already here. The only reasonable thing for investors to do is wait for this bear to go back into hibernation.
Figuring out when that will happen is tricky. Most so-called economic indicators have too much lag time to be useful forecasting tools. There are three market signals I like to watch to determine a bottom to a market: stock repurchases, merger-and-acquisition activity, and investor sentiment. Unfortunately, all three of those Street signs are blinking red right now, which tells me this bear market is far from over.
The first two of my indicators, share repurchases and merger activity, work because they can tell you what's occurring at that moment. When a CEO makes the decision to buy back shares or buy another company, a press release is issued the same day. A cluster of such activity means a lot of CEOs think their stocks are cheap or that now is the time to buy competitors. The third indicator, investor sentiment, is the hardest to get a handle on, but it's probably the most important factor in calling a market bottom.
Here's what these indicators are telling us right now:
Share Repurchases When a company's execs have a lot of cash on hand and think their stock is inordinately cheap, buying back stock from the public market and then retiring it is an easy way to lift the price. This became very popular in the '90s, as more and more executives saw increasing shareholder value as their primary responsibility. My most vivid memory of this was during the 1997 global-markets crisis. For four days in a row, I watched the world's markets slip by the hour. But the bottom only appeared when GE (GE
) announced it would start buying back shares on the open market. The move knocked enough sense into the heads of money managers for them to start buying, too, and the U.S. market quickly stabilized. Then the other markets began to turn around as well -- all within an hour of GE's announcement.
Unfortunately, no one has yet played the role of GE in today's market. The numbers, from Thomson Financial Securities Data, paint a bleak picture. From the beginning of 1999 to Feb. 26 of that year, there were 232 buyback announcements, worth a total of $26.9 billion. Over the same period in 2000, the stream of buybacks stayed respectable: 158 announcements, worth a huge $44.6 billion. Now, the flow has all but stopped: During the same period in 2001, only 81 announcements, worth $15.2 billion, have been made.
Share buybacks aren't a perfect measure of market sentiment. A recent study done by University of Texas finance professor James Westphal showed that of the shares companies say they'll buy back, only 60% are actually repurchased. That means either the stock price soared, negating the need for a buyback, or the company was less than candid about its plans and may have hoped the announcement alone would boost its shares.
That's why I'm wary of using buybacks to value individual stocks. But I think it's a great tool for measuring what executives of companies -- the people who know their business the best -- really think of their stock's price. And according to the numbers for the past two months, they don't think very highly of it.
Mergers and Acquisitions Another sign of what the players may be thinking is to look at M&A activity. It fills in a missing part of the share-repurchase picture because many companies simply don't have the cash to buy back their own shares. But others may be ready to pounce -- those with the cash and the desire to snap up either a competitor or an outfit with emerging technologies that might prove useful to them.
Yet so far, that's just not happening this year. According to MergerStat, there were 1,307 deals announced through the end of February this year, worth $93 billion. Compare that with last year's totals through the end of February: 1,714 deals, worth $399.7 billion. That's more than a 75% decrease in the dollar value of deals.
So, few are out there buying. "Everyone's waiting for the market to turn around before they start acquiring again," says Robert Teitelman, editor-in-chief of The Daily Deal, a merger newspaper. Indeed, one thing that might prompt a turnaround is a sudden storm of merger activity, as acquiring companies decide that the price is right. That hasn't happened yet.
Investor Sentiment Getting a handle on the psychology of the stock market can be tricky. That's why investor sentiment is the most nebulous of the market measures I use. There are all kinds of indexes, polls, and research reports that try to track it, but my favorite is the PaineWebber Index of Investor Optimism, which is based on polling data done by UBS Warburg (which bought PaineWebber last year) and the Gallup Organization. The index, which asks investors of various portfolio levels how positive they feel about the stock market, sits at 126 for February, which is only four points down from its January finish. It's also well above its baseline of 100 in 1996, when the index began -- itself a pretty optimistic time. According to UBS, 64% of investors polled consider now a good time to put money into the stock market.
So if people feel so good about the market, isn't that a sure sign stocks are on their way back? Actually, the UBS index is a reverse indicator. When people feel confident things are about to turn around, bear markets tend to continue. When all hope is extinguished and stocks are as popular as Saddam Hussein at a Veterans of Foreign Wars meeting, the market starts to go up.
One interesting thing the poll doesn't do is gauge sentiment by exchange: A very different mood prevails about the Nasdaq, which is down 61% since March, 2000, than about larger, nontechnology exchanges. "I would say there's a split personality in the U.S. right now," says Michael O'Sullivan, global debt and equity strategist for Commerzbank. "The Dow and the S&P 500 are not too far off their highs, and there's a lot of confidence out there. At the Nasdaq, things are blindly bearish."
But that's not to say the Nasdaq is experiencing the darkness before a glorious new dawn. "The days of egregious overvaluation are gone," says Joseph V. Battapaglia, chief market strategist for Gruntal & Co. Nevertheless, he says, the bright side is that "it's fairly clear there's no meaningful valuation issue among the Nasdaq's leadership." In other words, things are cheap. Don't expect to make quick gains again. But if most other investors are thinking the same way as Battapaglia, the Nasdaq's slow and painful turnaround could at least be on the horizon.
Jaffe writes about the markets for BusinessWeek Online
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Copyright 2001, Bloomberg L.P.
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