Back in April I was insisting that either the Fed is right or the market is right. Again, very interesting reading in retrospect, especially the comments from Fed Governor Guynn
<<April 4, 2001, SAN FRANCISCO -- Today was a difficult day, from both a personal and a market-related perspective.
On the market front, the Dow Jones Industrial Average rose 0.3% to 9515.42 after trading as high as 9625.90 and as low as 9375.72. The S&P 500 closed down 0.3% to 1103.25 after trading as high as 1117.50 and as low as 1091.99. The Nasdaq Composite Index closed down 2% to 1638.80, after trading as high as 1698.21 and as low as 1619.58.
Obviously, expectations for a rally to follow yesterday's heavy losses proved overly optimistic, yet again.
"I would have loved to have been able [to say] yesterday was a selling climax or the ultimate capitulation, but I wouldn't characterize it as that," said Anthony Cecin, manager of Nasdaq trading at U.S. Bancorp Piper Jaffray in Minneapolis. "We're stabilizing shakily from yesterday [but] it's fairly important to close flat to up and not head down again in the last hour."
Major averages did improve in the final hour but I was unable to reach the trader postclose to get his assessment on whether that was more important than the fact that only the Dow ended in positive territory.
While lacking clear answers, the session was consistent with what (among many others) Jim Bianco, president of Bianco Research in Barrington, Ill., described as a "bifurcated market."
Since the S&P 500's peak on March 24, 2000, the nine sectors in the index other than tech and communications were up an average of 9% through Friday, Bianco reported.
In the same time frame, the S&P tech and communication sectors have been "annihilated," skidding 62% and 38%, respectively, he said. "Other than trading rallies, [they] are going to have a hard time. But looking away from those stocks [and] the rest of the market is hanging in there."
I called Bianco to get his opinion on an issue raised by a thoughtful reader, Dr. Kendall S. Harmon, in Summerville, S.C.: that the market is saying "recession" (or worse), but the Federal Reserve is still saying "no."
This market vs. Fed donnybrook was on stark display today. While the averages made their point for continued weakness, several Fed governors said otherwise in separate comments (culled from Reuters):
The first quarter "felt like very, very slow growth [but] we haven't had a negative [growth] quarter yet," Dallas Fed president Robert McTeer said. Using the classic definition of recession as two consecutive quarters of negative GDP, McTeer mused: "Have we been in a recession? The answer is no."
Chicago Fed president Michael Moskow expressed concern about the possibility of rising unemployment, adding that "when you survey the U.S. economy right now, the risk of economic weakness is greater than that of inflation." But "that doesn't necessarily mean we're in recession. It means that our economy is operating below its potential."
Finally, Atlanta Fed president Jack Guynn said, "my sense is that the rate of deterioration has slowed. I think there have been some signs recently that suggest if we're not at the bottom, that we may be close to the bottom. I would think that hopefully a good bit of the adjustment is behind us."
Fed chairman Alan Greenspan did not directly address the economy's state during his testimony before the Senate Finance Committee today. But it's probably not a stretch to say the regional Fed heads expressed views at least generally consistent with those of their boss.
Downturn, Not Disaster
According to Bianco, the sector stats cited above suggest that the stock market -- excluding tech and communications -- is "largely in synch with the Fed's" argument that while economic growth has clearly slowed, it hasn't evaporated.
Bianco has been making the case about the devastation in tech stocks masking relative strength elsewhere for some time. He's also argued that the economy is not as weak as some contend and that inflation may prove problematic down the road.
That's not to say he's oblivious to the fact that the economy has weakened. The researcher just believes the stock market (again), excluding tech, has thus far been consistent with an economy that's slowed from more than 8% GDP growth in late 1999 to near 1% today.
Taking this point a bit further, Bianco observed that the S&P Barra Value Index represents more than $5 trillion in market cap and trades with a price-to-earnings ratio in the midteens. "There's no doubt tech is in trouble, but if you look past [tech], there's a bunch of cheap stocks out there that had been making money before the Internet, which look very reasonable," he suggested. "But we're all so focused on tech [that] no one cares."
Anticipating what many readers are no doubt thinking, I asked Bianco about the possibility that value stocks soon follow their growth counterparts into the quagmire. He acknowledged that risk, but mused: "If value does crater, how far do they have to go before people consider them unbelievably cheap in a low-interest-rate environment?"
By comparison, the S&P Barra Growth Index still trades with a P/E around 35, he noted, suggesting that most tech stocks remain far from cheap despite the carnage.
Finally, in this Fed vs. market debate, there's the issue of what the bond market -- traditionally more attuned to central bank policies -- is saying. Fed critics say the fact that Treasury securities, save for the 30-year bond, are all sporting yields below the current fed funds target suggests the Fed is way behind the easing curve.
True, but despite the "disaster" in the first quarter, the long bond has gained only three basis points since the beginning of the year, when it yielded 5.50%, Bianco noted. Additionally, the yield curve has been steepening and is approaching a so-called normal slope, in which short-dated maturities yield less than longer-dated ones.
New Nasdaq lows, the Lucent Technologies (LU:NYSE - news) scuttlebutt and/or more bad news from Cisco Systems (CSCO:Nasdaq - news) are unlikely to materially aid the bond market, he continued. Similarly, he argued that tech stocks have fallen so far that the resulting "reverse wealth effect" and changes in behavior already have largely occurred.
From December 1999 through March 2000, about $360 billion in unrealized profits in equity mutual funds was eliminated, Bianco Research estimates. Approximately half of those losses were in aggressive growth funds.
"What bonds really want is for the Dow to start diving and nontech stocks to go down [further] to crank up the reverse wealth effect [again] in a big way," Bianco said. But recent action in the bond market and the fact the vast majority of earnings warnings remain tech-centered has him "betting nontechs will hang in."
All this, of course, is the glass-is-half-full scenario, which I know fewer and fewer investors are willing to sip from these days. >>
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