Time for Investors to Spread Their Wings?
As profits head for a strong finish, the correction leaves a bigger pool of bargain shares
The market's recent dips and dives have investors in a cold sweat. It's no wonder. Fear of another rate increase, plus Federal Reserve Chairman Alan Greenspan's admonition that investors need to be more aware of stock-market risk, have given the public a bad case of jitters.
Still, it seems the best advice for investors is to hold on and ride out the storm. There's good news ahead that will buoy the market: Inflation pressures are not building, despite the larger-than-anticipated increase in the producer price index for September. Concerns over Y2K computer glitches will be over as we pass into the new millennium. Corporate profits are their strongest in four years, with third- and fourth-quarter estimates a healthy 20% and 19% over last year, according to I/B/E/S/ Inc., the earnings research firm. The correction itself may have eliminated the need for the Fed--which is concerned that the sky-high market is pumping up consumer spending--to raise rates.
Not only that, according to market timers, bull-market season is on its way. Since 1964, the stock market has performed better from November to May, when investors pour money from bonuses and distributions into stocks, while slumping into the doldrums from June to October, according to Sy Harding, publisher of a newsletter about market-timing, Sy Harding's Street Smart Report. Also, a market correction (chart) has made stocks more reasonably priced and attractive to investors.
There's no arguing that a correction has taken place. The Dow Jones industrial average finished the week ending Oct. 15th down 630 points, or 5.9%--the worst percentage performance in a decade. And for two consecutive trading days, Oct. 15th and Oct. 18th, the Dow even dipped below the mystical 10,000 mark. The Standard & Poor's 500-stock index has also fared poorly, down 10% from its year-to-date high. Even the tech-heavy Nasdaq Composite Index has had some wind knocked out of it. It is down 12% from its year high.
STEALTH BEAR MARKET? Perhaps more important, the average New York Stock Exchange stock is some 30% off its 52-week high. This lends credence to the idea that a stealth bear market--a market that appears healthier than it actually is because a handful of stocks have posted stellar performances--has been occurring right under our noses. 'Technically, we've been in a bull market, but the truth is that the average stock has stunk,' says Richard Bernstein, chief quantitative analyst at Merrill Lynch & Co. In fact, from the beginning of the year to the end of September, all of the 4.35% gain in the S&P 500 could be attributed to the eight largest stocks measured by their market value, according to Salomon Smith Barney.
Some strategists say that the correction is merely the price that investors must pay for a sustained bull market in stocks. 'Once we're out of this, which could be in a couple of months, we'll have a better market because it will have better breadth and more reasonable valuations,' says John L. Manley Jr., who is market strategist for Salomon Smith Barney. In fact, Manley says that the sharp decline in the indexes, the S&P 500 in particular, bodes well for the stock market because it will force investors to look elsewhere for gains. 'With a flattened return, there's a tendency to spread their wings and go into other areas like value, small-caps, or international,' Manley says.
That is, as long as investors aren't too spooked by the prospect of rising rates. Most strategists say it is likely that the Fed will raise rates for the third time this year in November. But that's not bad. 'By the middle of the fourth quarter, the Fed will be done with its program, and rate pressures will abate,' says Peter J. Canelo, U.S. equity strategist at Morgan Stanley Dean Witter. 'The only thing the market can't handle is uncertainty.' Canelo says that after the rate increases are over, inflation should return to the 2.5% to 3% level that prevailed prior to the Asian crisis. 'We're pretty confident that productivity remains strong and the American export machine is cranking up again,' he says.
CHEAP FINANCIAL STOCKS. Another reason to be optimistic: Investors will likely continue to view stock market downturns as buying opportunities. 'It has worked in the past. Why should this time be any different?' says Canelo. In fact, this was evident as recently as Oct. 19th, when the consumer price index came in showing slower growth than anticipated. Wall Street rallied, partly thanks to reduced inflation fears, but largely because a number of beaten-up stocks were easy pickings. Still, there's one caveat to this: Investors could be sent into a selling frenzy if the Dow dips and lingers below the psychologically important 10,000 level.
Barring that, an area to consider is beaten-down financial stocks, which are trading at a 40% discount to the market. 'Their relative price-earnings ratios are similar to where they were during the Gulf War, yet their profits are strong,' says Salomon Smith Barney's Manley. Some to look at: J.P. Morgan (JPM), Chase Manhattan Bank (CMB), and Citigroup (C), all of which posted strong earnings this week. Also, in an improving global scenario, cyclical stocks with heavy overseas exposure and low price-earnings ratios such as John Deere & Co. (DE) and Alcoa Inc. (AA) may present good values. Underperforming drug stocks also offer buying opportunities. Shares of Merck & Co. (MRK) and Schering-Plough Corp. (SGP) are 15% and 25% off their yearly highs. And there are always tech stocks. The market darlings are now suffering along with other big stocks. America Online (AOL), for instance, is 30% lower than its year-to-date high, and Intel (INTC) is off 25%.
The market turmoil may not be pretty, but wise investors will bear in mind the end result: a more robust and sustainable market.
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By Marcia Vickers in New York |
