Falling Stocks Bring Out Paranoia
Updated 12:07 AM ET August 15, 1999
By Pierre Belec
NEW YORK (Reuters) - The stock market's headline-grabbing slide has once again brought out the Wall Street Ministers of Paranoia.
After nearly five years of spectacular gains, Wall Streeters are starting to wonder about the durability of the bull market. Things have apparently changed a lot since the Federal Reserve hinted that it may raise interest rates later this month in a bid to keep inflation from resurfacing in the economy.
What's unsettling for the market is that history has shown that whenever investors are in that frame of mind, it's usually a good sign that caution is warranted.
The Dow Jones industrial average, the Nasdaq Composite index and the Standard & Poor's 500 index have been locked in a slow moving but steady erosion since setting record highs in July.
Some analysts see trouble in the way the market is behaving.
The daily trading volumes have shrunk, which suggests that investors' appetite for risk is low. They are not running back to snatch bargains in the wreckage of battered stocks. The light volumes have also caused stocks to fluctuate wildly.
The ratio of stocks that fall vs. those that rise has increased sharply, which is a no-no for the market. Also, a bigger number of stocks are making new 52-week lows.
There's more bad news.
Internet stocks -- the former shooting stars -- have had their own private crash. Some 90 percent of the Internet shares that were launched in initial public offerings in July are now trading below the level at which they made their debut on the Street.
What a difference a couple of months makes. Just last April, during the Internet mania, the stocks would double and triple after an IPO. Now, people view many of the Internets as Lemmings.Com.
Even the blue-chip Internet stocks, such as America Online and Amazon.com have fallen precipitously from their peaks.
The slaughter of Internet stocks has brought the technology-laced Nasdaq Composite index down 10 percent from its July high of 2,864.48, which fits the definition of a correction. Another 10 percent plunge could signal the start of a bear market.
The Dow is down 3 percent from its peak of 11,209.84 and the Standard & Poor's 500 index has fallen 7 percent from its high of 1,418.78.
TheStreet Com's index of the leading Internet companies has plummeted 40 percent from its April high.
"I'm more pessimistic than ever about this market and, in fact, I'm sort of scared about what could happen," said Raymond DeVoe Jr., market strategist for Legg Mason, Wood
Walker. "Back in the 1929 crash, just 2 million people were in the market but now, half of American households own stocks."
He said a bear market is a mental process rather than a statistic and the risk is that investors can quickly push the panic button if their losses are too large.
"I'll bet that if the market drops 20 percent and stays there for more than a week, I'll guarantee we will see a lot of dumping by people and it could mean a drop of 40 percent
or more," he said.
"Investors can lose 10 to 20 percent but they'll still stay in the market. But if they lose 40 or 50 percent of their holdings, they'll be out of the market completely," DeVoe said.
Right now, few investors are running for the exits.
The reason: Investors have made so much money in the market over the years, they now believe they could easily ride out a big market slump.
"To those people, I would say: 'That's what you're saying now, but let's wait and see what you will do when it does happen,"' DeVoe said. "It's easy to talk bravely with the market having acted beautifully for the last 17 years."
What are the tricks to staying alive in a bear market?.
"The 'buy on dips' mantra that has worked in the past becomes 'sell on the rallies,' because that may be the only time there is liquidity to get out of the market," he said.
DeVoe said the Dow would need to retreat 45 percent to 6,000, just simply to return to the fair valuation of the last 72 years. But the trouble is that bear markets can quickly get out of control when the selling pressure feeds on itself.
"Bear markets never stop at medium valuation levels," DeVoe said. "That's what happened during the real bad bear markets of '73 and '74."
In the nasty battering of the early 1970s, the Dow, which measures the performance of 30 blue-chip stocks, plunged 44 percent of its value. The damage was much worse in the broader market as stocks lost 80 percent to 90 percent of their value.
Alan Newman, the long-time bear at the Crosscurrents investment letter, said the one thing that bothers him about this market is that investors have no fear.
"As my own dentist tells me, 'What does it matter, if I lose 20 percent? It's not a big deal because I'm still way ahead,"' Newman said. "All I see is complacency."
The drop in trading activity to the lowest levels of the year is an unsettling development.
"Bull markets thrive on volume and we have not been able to maintain high volumes for some time," said Newman. "I just can't see how stocks can recover from this selloff and keep going higher."
Investors may have been lulled into a sense of security by the market's slow-motion fall.
"We have not had any types of climax or washout and this is the most typical sign that we are in a bear market...just day after day of constant erosion."
Newman said the last time he was bullish on stocks was when the Dow first crossed 4,000 in 1985. From that day on, he maintained a very conservative strategy and became a die-hard bear in late 1995, when the Dow jumped to 6,000.
"Sure, I didn't make my clients as much money as I would have liked to, but I paid off to a mania that was just impossible to anticipate," he said.
Newman is betting that the Dow could slide to 9,600, which would amount to a correction of some 15 percent.
Many things could provoke a nasty shakeout, including a series of unexpected interest-rate increases or some stress on the market from a financial crisis, such as another problem with a large managed fund.
A currency devaluation by China or South America could also be negative for global markets.
Are people staying in stocks because it's the market that offers the biggest rewards?.
"Too many people believe that there are no long-term risks in owning stocks and there's just short-term volatility," DeVoe said. "Risk has been redefined as the deviation from a statistical benchmark rather than the most potential for losses."
The market's spectacular ascent, along with its ability to recover from setbacks since 1987, may have reinforced investors' confidence in stocks.
DeVoe said the next bear market -- assuming there is one -- will be very sharp and may be followed by a rapid rebound.
A warning: "The most dangerous time to buy in a bear market is on a dip, and the smartest move would be to sell stocks when the market recovers," he said.
For the week, the Dow Jones industrial average was up 259.62 points at 10,973.65. The Nasdaq Composite index was up 87.19 at 2,635.16 and the Standard & Poor's 500 index gained 13.97 at 1,327.68.
>>>About 20 percent of the industry groups fired off MACD
>>>buy signals on Friday alone, including several internet
>>>groups. |
