Just a little fodder for thought, nothing we don't all already know from experience...
For Thousands Of Stocks, Bear Market Has Already Arrived
July 30, 1998 12:04 AM
By Greg Ip and Aaron Lucchetti, Staff Reporters of The
Wall Street Journal
For thousands of stocks, the bear market has already
arrived.
A week and a half of selling pressure has left the Dow
Jones Industrial Average down 4.5% from its closing
record set July 17. That doesn't even qualify as a
correction, commonly defined as a 10% drop for an
index or stock.
But behind that relatively modest blue-chip retreat is a
far more dismal story for the majority of stocks.
As of Tuesday night, the average New York Stock
Exchange stock was down 24.3% from its 52-week
high. That's the biggest such decline since 1990, the last
official bear market, according to equity strategists at
Salomon Smith Barney. (A bear market is typically
defined as a 20% or greater decline in the Dow Jones
industrials.) More stocks have been making new lows
than new highs most days since late May.
On the Nasdaq Stock Market, the average stock has
declined an even more dramatic 35%. Indeed, fully 30%
of Big Board stocks and 51% of Nasdaq stocks are
down 30% or more from their 52-week highs.
"The only thing making the market look good is the
largest of the large-cap stocks," says Jeffrey Warantz,
equity strategist at Salomon Smith Barney.
Scott M. Black, president of Delphi Management, adds,
"We haven't seen this type of divergence since the top of
the Nifty Fifty" in 1973-a reference to the craze for big
stocks in that year. "The large-cap stocks are masking
what's going on." By some measures, he says, "We've
been in a bear market for a long time."
The common explanation for the divergence is that fund
managers need to stay fully invested, but, wary of how
earnings problems can crater a stock, are
disproportionately favoring the perceived security of
blue-chip growth stocks.
Stephen Dalton, senior vice president at First Capital
Group, a unit of First Union Corp., says every time an
event upsets the market, investors dump stocks, and "if
you're in one of those less-than-liquid stocks where a
fundamental accident takes place, the stock goes down
50%." When confidence returns, managers quickly
return to the 50 biggest, most liquid (easy to trade)
stocks, but are slower to re-embrace the secondary
names, he says.
The smallest stocks have been hardest hit. While
Standard & Poor's 500-stock index is still up 16% so
far this year, the Russell 2000 index of smaller stocks
has lost 2.5% and is down 13.2% from its April high.
Indeed, Salomon Smith Barney calculates that the
average stock with a market value of $250 million or
less is down 43% from its 52-week high, although many
were in a larger-cap category at their 52-week high.
Even within the S&P 500, however, performance has
gone disproportionately to the largest. Just 78 stocks
provided all the year-to-date return of the S&P 500
through Tuesday, according to Salomon Smith Barney;
the gainers in the remaining 420 just offset the losers.
Indeed, only five stocks -- Microsoft, Lucent
Technologies, General Electric, Wal-Mart Stores and
Pfizer -- provided a quarter of the index's return. (The
contribution of large stocks is slightly overstated because
some of the stocks now defined as largest weren't
among the largest at the beginning of the period.)
"The smaller the stock, the more of a bear market,"
that's been experienced recently, says James Melcher,
president of Balestra Capital Ltd. in New York. Earlier
this year, Mr. Melcher reduced the small-stock
exposure in his stock portfolios to 15% from 30%.
"There's just no constituency to buy these small-cap
stocks," says Mr. Melcher. "Those who bought them for
value have seen them go nowhere." Mr. Melcher says
the proliferation of money flowing into mutual funds has
helped large caps because managers need a place to put
the money to work, and the stocks in the Russell index
are simply too small to fit in. "The money flowing in is
coming from funds, and money flowing out is from
smaller stocks and individual stock holdings," he says.
Mr. Melcher isn't alone. Many fund managers appear to
have increased the average size of the stocks they own
this year. The median capitalization in large-stock mutual
funds rose 23% to $26.2 billion between the end of last
year and the end of June this year, while it rose 33% for
midcap managers to $4.4 billion but a more modest
8.7% for small-cap managers, according to Morningstar
Inc. Some of that increase obviously results from
appreciation in the stocks themselves, but a good
portion is probably also due to portfolio changes since in
each case those gains are larger than the funds' average
return.
Laszlo Birinyi, president of Birinyi Associates, examines
how much stocks are trading on upticks, i.e., at prices
above their last trade price, to determine where buying
pressure is relatively more pronounced, and concludes
that 25% of "net buying" on the New York Stock
Exchange now is in the 30 Dow Jones industrial stocks,
compared with less than 20% a year ago. Though the
increase doesn't seem huge, it still represents billions of
dollars going into just 30 stocks in a short period of
time, says Mr. Birinyi.
Eugene Gardner, a portfolio manager for David L.
Babson & Co. in Cambridge, Mass., says he has no
problem finding cheap small stocks these days, mainly
because so many of them have gotten beaten up
recently. "It's been a pretty nasty month" for small caps,
he says. And while he finds it relatively easy to buy
small-cap stocks because "there are a lot of willing
sellers, it gets a little more dicey" when trying to unload a
stock, he says.
Balestra's Mr. Melcher says he is now unsure whether
small caps can outperform unless a correction knocks all
valuations down more broadly. "This is a momentum
market in every sense," he says. "Investors are buying
into stocks that are going up; tell me why Gillette is
worth 50 times earnings or Coca-Cola is 55 with
modest growth rates. There's no valuation in this market.
It's lost all connection with valuation."
Some of this does appear fundamentally driven. Smaller
stocks are feeling the effects of an expected slowdown
in the global economy, suggests Satya Pradhuman,
director of small-cap research at Merrill Lynch. Mr.
Pradhuman reported earlier this month that earnings
momentum was slowing for smaller companies for the
first time since the first quarter of 1997, while large-cap
earnings momentum kept growing.
"A slowing corporate profit cycle appears to be taking a
toll on smaller companies," he says. "Small-cap earnings
can be more volatile and the first-quarter was no
exception. Larger firms typically have more room to
offset adverse conditions" he says.
Whether this divergence in the market is the harbinger of
a more severe correction for the major indexes is
fiercely debated. The rally to July's high "was extremely
narrow and accompanied by a rising complacency," says
Tom McManus, an independent strategist. "That should
be looked at as a danger sign. It will take more than a
week to unwind the complacency that existed just a
week ago."
But Neil Eigen, a value-stock manager at J&W
Seligman, says a more severe correction would require a
pickup in inflation. "I'd like the market to move sideways
for six months" so that earnings expand to justify stock
prices, he says.
Copyright (c) 1998 Dow Jones & Company, Inc.
All Rights Reserved |
