STREET WISE
By Amey Stone and David Shook
SEPTEMBER 18, 2001
Watch Out for Whiplash
Stocks restarted trading with a rough ride. Could it get worse? Sure. Chances are, though, that the calm and the patient will be rewarded
We can all breathe easier that the stock market didn't crash when trading resumed on Sept. 17. Although the major indexes plunged as expected at the open, trading was orderly, and enough buyers were out there to keep the indexes from cascading downward. Not to be a Pollyanna about it, but the 7% drops in the Dow Jones industrials and the Nasdaq and the 5% fall in the Standard & Poor's 500-stock index weren't so shocking considering what could have happened. Many Wall Street pros feared the damage would be much worse -- especially given the 10% to 15% losses that most foreign bourses suffered since the terrorist attack on U.S. soil a week ago. Don't forget, in October, 1987, the Dow fell nearly 23% in one day.
Now comes the hard part. The markets are likely in for a week of volatile trading after being shut down for the longest stretch since the Great Depression. For most people the smartest strategy will be to stay on the sidelines until emotions cool. "This selling has an emotional base," says Milton Ezrati, market strategist and senior economist at Lord, Abbett & Co. "But the more time passes without another shock, the more people will again turn to company fundamentals instead of their guts."
The terrorist attack that badly damaged the Pentagon and leveled the World Trade Center, killing thousands of Americans, will have a profound short-term effect on the markets. Virtually every company's results will feel the tragedy's impact in some way, says Chuck Hill, director of research at First Call. He expects corporate earnings to fall about 20% from last year's levels in the third quarter, which ends in less than two weeks. Prior to the Sept. 11 attacks, he thought the decline would be 17%.
"A LITTLE FUZZY." For the fourth quarter, while consensus analyst estimates still call for a decline of only 3%, Hill thinks that quarter's earnings are likely to fall 10% to 15% when all is said and done. "Things are still a little fuzzy," he says. But analysts likely will be slashing estimates all month.
A gloomy scenario? Depends on how you view it. Many market strategists believe the past week's events may force the economy to rebound faster than it might have otherwise. "Whereas before it might have taken six months for the downside to unfold to a point where the bottom might be in place, maybe we'll get the bottoming process over a lot quicker," says Terry Danish, chief technical analyst at Investec Ernst.
It's easy to forget that a week ago more than a few analysts were cautioning investors that many stocks were overvalued and that by historical standards, price-earnings ratios, a key gauge of a stock's value, were still too high. Some investment strategists, including Danish, think the market may hit bottom as soon as Sept. 18. While that may be wishful thinking, CIBC World Markets strategist Sobodh Kumar thinks the market could very well end the week above where it started. But Ezrati suggests that investors avoid looking for short-term trading opportunities in the days ahead. "The only way to succeed in this environment is to keep a long-term perspective," he says.
MORE FORGIVING? For the vast majority of companies, the hit to profits and revenues will be negative -- especially for the airline, entertainment, and travel industries. A few sectors, like defense or construction, may ultimately benefit from the new emphasis on national security and rebuilding efforts. But investors will have to be patient. "Most of the positives will not appear until next year," says Ezrati. "The negatives all appear up-front."
So let's stay on the bright side for the moment. The Street is likely to be more forgiving than usual of worsening corporate results, given circumstances that are undeniably beyond management's control. "Investors will be more tolerant of companies saying business is bad," says Jeff Bernstein, senior portfolio manager at Pilgrim Funds. And Hill thinks the economy could be stronger in a year after stock overvaluations have been completely wrung out of the market. "There is a very good chance that we'll be exiting 2001 on a stronger basis than we might have been otherwise," he says. "The pain and suffering in between will be greater. But we could well be better off by the end of 2002."
Of course, market strategists offer this analysis with a caveat: All bets are off if the U.S. is hit with another heavy-toll terrorist attack or if American retaliation escalates into drawn-out, all-out war. Hill says his optimism for next year is "assuming this doesn't snowball into some big conflagration."
"DANGEROUS PLACE." Certainly, investors are assuming a swift military response, but the long-term effects of armed conflict on the markets can't be known until it becomes clear how successful it is -- and at what cost. "We may get a few very visible victories that immediately send stock prices soaring," wrote Edward Yardeni, chief investment strategist for Deutsche Bank Alex. Brown, in a Sept. 16 letter to investors. "But then what? The world always was a dangerous place for most people. Now it is also dangerous for us."
Smart investors will adjust their horizons out a year or so. By that time, fiscal stimulus from Washington as well as further Federal Reserve-engineered interest rate cuts will probably have boosted the economy and corporate earnings. "People should be thinking in terms of how to benefit from improved earnings next year," says CIBC's Kumar.
Yes, a sharp sell-off and gloomy short-term outlook for the economy and corporate earnings pose risks. But the savvy will keep their heads. "You could really be creating more problems for yourself if you get out now," says Bernstein. "Better to close your eyes and know that the medicine being delivered for the patient is eventually going to start working."
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