'Locust Cycle' May Bug Street for Years
Sat May 4, 6:58 AM ET
By Pierre Belec
NEW YORK (Reuters) - The stock market may be in the early stages of the "Locust Cycle," a plague that brings investors years of unappealing returns before the good times start to roll again.
If this is the market's destiny, then people should abandon their deeply ingrained belief that stocks always bounce back. In other words, the "buy on dip" mentality may not be the smartest strategy.
Indeed, one of the biggest fictions on Wall Street is the market always comes back. It's a mindset formed during the 1990s when stocks were the great wealth spinners.
"That's what happens during bull markets -- the market always rebounds, that is, until it ends," says Ray DeVoe, veteran Wall Streeter and publisher of the DeVoe Report. "This is most investors' only experience in the stock market during the 18 years of rising prices."
He believes that investors, itching for a return of the bull market that hung on from 1982 to 2000, may instead be faced with a profit drought that could last for years. It's called the "Locust Cycle," in which the crop-ravaging insect lies dormant for 17 years and then awakens for 17 years of activity.
"People do not realize that there can be long periods when the market goes nowhere or acts poorly," DeVoe says.
It happened after the crash of 1929 and again at the conclusion of the "Nifty 50" market in the 1970s.
After the 1929 bloodbath, the Dow Jones industrial average went into a head-spinning plunge of 82 percent by the summer of 1932. Then, it took the Dow 25 years to return to its pre-crash high, says DeVoe, who was born the year after the 1929 debacle.
"And many stocks, the ones that survived the crash, such as Radio Corporation of America and General Electric, took 40 to 60 years to surpass the 1928-1929 levels," DeVoe says.
In many ways, there are similarities between the market of the 1970s when a handful of stocks -- known as the Nifty 50 -- ruled the Street -- and the bubble of the late 1990s. In the '70s, investors concentrated on only 50 stocks, known as "one-decision stocks" such as Polaroid, which produced steady wealth. But the end came in 1972. The pain lasted until 1982.
Before 1982, the Dow was stuck between 800 and 900 points.
NEED BATHROOM WALLPAPER?
It may be too early to tell for sure whether stocks are entering a secular bear market or a dormant cycle.
"But today's valuations appear to be anticipating a rapid resurgence of corporate earnings, which now looks less and less likely," says DeVoe. "The market may come back, but a lot of stocks won't."
The lesson?
"Stock certificates can make colorful wallpaper for downstairs bathrooms and constant reminders to be more careful in the future," he says.
"The illusion of inevitability about the stock market always coming back persists," he says. "But it would take a sharp drop in consumer confidence, or a sustained lengthy decline in the stock market, or both, to shatter that illusion."
People may be starting to get the idea. Using the stock market as a proxy, investors are now sending the message of what they believe the economy and corporate profits will be like down the road.
This week, the Standard & Poor's 500 and Nasdaq Composite indexes slumped to the lowest levels since October. A week earlier, the Dow, the S&P 500 and the Nasdaq turned in their worst weekly performance since the week after the Sept. 11 attacks on the United States as investors worried about corporate earnings in the first quarter. More disturbing have been the slew of disappointing earnings forecasts for the rest of the year.
On Friday, stocks fell after the government reported the unemployment rate jumped in April to 6 percent, its highest level in more than 7-1/2 years, from 5.7 percent in March. The silver lining, though, in that cloud over the job market is this: The Federal Reserve (news - web sites)'s policy-makers, who will meet next week, probably will wait awhile longer before raising interest rates.
While more than 60 percent of companies beat analysts' lowered expectations in the first quarter, there seems to be a newfound realization the numbers only looked good because chief executive officers had talked down the Street's expectations. Indeed, the latest mind game in the post-Enron era is to beat analysts' estimates by a penny or so and to call the stocks winners, DeVoe says.
"Another variation is to report 'EBBS' or 'earnings before the bad stuff,' he says. "One company recently even reported earnings per share before costs."
DeVoe says Enron's misdeeds exposed the types of aggressive accounting that goes on in bull markets.
"Now, all corporate earnings are suspect," he says. "With so much of the previous bull market earnings shown to be illusory, how can investors trust reported earnings now? More conservative or realistic accounting practices would certainly result in lower per-share results."
From an economic standpoint, the monstrous leap of 5.8 percent in the gross domestic product in the first quarter, the fastest growth in two years, looked impressive.
TEMPORARY BOOSTS DON'T LAST
But the reality is the strength came from a spurt of rebuilding of bare-bone inventories by recession-hit businesses, which contributed 53 percent to total GDP (news - web sites) growth and final sales -- minus inventories -- were nearly flat. The smart money does not expect a repeat performance in the second quarter. The betting is for sub-par growth for the rest of the year.
Investors may be facing the weakest market recovery since the late 1970s as corporate earnings continue to disappoint, even as the economy rebounds. Back in the '70s, inflation was rampant and investors/speculators poured lots of money into gold and silver -- the favored inflation hedges. Gold skyrocketed to $850 an ounce from $35 and silver zoomed to $50 an ounce from less than $2.
Gold is back in the spotlight, after climbing to a two-year high of $312 earlier this week, partly on jitters over the Middle East mess, which threatens to disrupt oil supplies. While inflation is not the trigger for the current speculative demand for gold, the fact that there's so much uncertainty about the wisdom to be in stocks after March 2000 is playing a big role in the minds of investors.
In fact, gold-oriented mutual funds were some of the best performers in the first quarter.
People's taste for hard assets has also spread to real estate, which is giving investors the opportunity to not only hedge against inflation, but to get a better return than they can in the stock market.
The mental state of investors will decide whether there is another bull market or a down-and-out bear market.
Worth remembering: In order for stocks to rise, investors must assume that Corporate America will deliver the numbers, which is not exactly the wisest way to think in the current brutal business environment.
Millions of investors who have lost trillions of dollars since early 2000 now know there are no sure things on the Street and they are not as eager to jump back into the market with both feet. Judging by the low trading volume in the major markets, the path of least resistance for stocks may be down until corporate earnings crawl back and the recovery can be sustained.
It's fair to say that many investors have thrown in the towel after the market's nice rally in the fourth quarter of 2001 turned out to be a head fake.
The market's dismal showing may have convinced die-hard bulls about the difference between the speculative and the investment merits of being in stocks.
Although the economy appears to be pulling out of a business-led recession, it would be a great error for investors to expect companies, which are already under intense pricing and earnings pressure, to boost capital spending amid what is shaping up to be a profitless recovery.
For the week, the Dow Jones industrial average gained 1 percent or 95.91 points to end Friday at 10,006.63, while the broad Standard & Poor's 500 index was off 0.3 percent, or 2.89 points, at 1,073.43, and the tech-driven Nasdaq composite index fell 3 percent or 50.86 points to close at 1,613.03.
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