A "Wall of Worry" Boxes In Investors


By Amy Tsao The more bearish of Wall Street pundits have been fretting lately over a phenomenon called the double-dip -- a post-recession stint of negative growth. And though recent lackluster data are making the nascent rebound look a bit pokey, most analysts are still betting against a double dip in 2002. Better -- albeit modestly better -- times are upon us. "This year is a tough work-out period," says Russell Sheldon, an economist at Nesbitt Burns, Bank of Montreal's equity subsidiary. "But a deep concern about a double dip is premature."

Try telling that to investors. Despite the Commerce Dept.'s initial gross domestic product report, which showed the economy growing at a startling 5.8% annual rate in the first three months of 2002, the markets are being dragged down by fears that the economy is in jeopardy.

Instead, investors focused on the fact that the GDP figure was helped significantly by companies' push to replenish inventories after last year's radical slimdown. Inventory restocking is unlikely to be repeated in subsequent quarters. And even though consumer spending remained buoyant and government spending surged, investors don't seem convinced that the consumer or Uncle Sam can maintain those levels.

WORLD OF WOE. Don't expect the pessimism to lift any time soon, either. In the near term, a prolonged string of confidence-shaking headlines could keep investors in the dumps for weeks, maybe months. "With a recovery beginning and two years of declining stock prices behind us, you would think we'd be in for a rally," says Chuck Gabriel of Prudential Securities. "And yet it's almost as if the fates have conspired to make us climb one last wall of worry."

Gabriel sees high-profile probes of analysts' research practices, ongoing investigations into aggressive accounting methods, and renewal of asbestos-litigation risks as added burdens to a stock market already stumbling under the news of disappointing first-quarter earnings. He puts the possibility of a U.S. "outright declaration of war" against Iraq before the end of the year at about 70%. Also, the unemployment picture continues to be dismal and is expected to worsen in the near-term.

It isn't all gloom and doom. Most strategists' are sticking to their 2002 outlooks, which estimate that the markets will finish the year higher. That would be an improvement over the past two years, but gains are likely to be puny. And spring and early summer could be rough for stocks until the economic data and earnings gain some momentum. So far this year, the Dow Jones industrials average is down 2%, and the tech-heavy Nasdaq has tumbled close to 15%.

WINDED CONSUMERS? Long-term investors may want to wait until stocks become even more beaten down before jumping in with both feet. "We are not inclined to think this is a time to be really aggressive," adds David Testa, chief investment officer at T. Rowe Price Associates. Economists predict that second-quarter GDP will grow at an annual rate of no more than 3%.

On the consumer side, some of the spurs to first-quarter growth -- including rebates from auto makers, the bonanza of income-tax refunds, low energy costs, rock-bottom borrowing costs, and warmer-than-usual winter weather -- will disappear in coming months.

Already, other measures of consumer strength, beyond spending, are showing weakness. There was a bigger-than-expected decline in the University of Michigan's consumer sentiment index for April. The housing market, which has been a driving force of the economy the past year, is losing steam. Both existing and new home sales fell in March. For most analysts, it wouldn't be a big surprise for April to show some cooling down. Also in March, late payments on credit-card bills rose to the highest level since 1997, while losses from uncollectable debt surged to an 11-year high.

"PAYBACK TIME." Meanwhile, companies will still be expected to show some long-awaited gains in the second and third quarters. The second quarter is expected to be the first period of profit growth in a year's time. But businesses' rush to replenish inventories may have taken a bite out of future growth. "The second quarter is going to be payback time," Sheldon says.

And since stocks are still priced high relative to their earnings potential, they could be knocked down quite easily if companies fall short of expectations. The Standard & Poor's 500-stock index is trading at a high price-to-earnings ratio of 30, based on projected 2002 earnings estimates, compared to a 20-year historical average of 20.

Even if the second-quarter earnings season has some upside surprises, investors' pessimism may prevail, further hobbling the markets. Stalwarts are already getting knocked around. Just look at IBM (IBM), which was investors' favorite tech company through the downturn. On Apr. 8, shares sold off 10% after IBM warned of an earnings shortfall for the first time since the early 1990s. Then in mid-April, shares in the tech bellwether lost even more ground after rumors of a Securities & Exchange Commission investigation circulated. Even though rumors proved unfounded, the stock is now at $84 per share, far below its 52-week high of $126.

A PINCH ON PROJECTS. If levels of capital spending don't improve, that will be another impediment to the already fragile markets. The advance reading of first-quarter GDP showed that business investment fell 5.7%. "A trough in activity appears to have been reached late in the fourth quarter," says Ray Stone, managing director and economist at Stone & McCarthy. "But [spending] is still not much above that." High corporate debt levels and less-than-sizzling profits are putting the pinch on new projects. Stone predicts that capital spending will "take a couple more quarters to have meaningful improvement."

So instead of a leap out of the downturn, expect to see something more like a crawl. Apart from the GDP report, other data are already suggesting weakness -- including the decline in orders of big-ticket goods like refrigerators in March and high levels of unemployment claims data for the week ended Apr. 20. At least through the first half of the year and perhaps into the third quarter, less positive economic news will likely dominate, which will keep any hopes for a big stock market rally shelved.

How quickly some forget the U.S. economy's impressive rebound over the last several months -- coming out of a recession speedily even after the terrorist attacks of September 11, which many had feared would trigger economic devastation. Despite that, investors haven't gotten the reassurances they need to create the foundation for a new bull market. While the recovery won't likely unravel, better strap yourself in for a shaky market ride for most of 2002. Tsao covers financial markets for BusinessWeek Online in New York


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