Not just me....
Will Stocks Belly Flop This Summer, Repeat 1998?
By Pierre Belec
NEW YORK (Reuters) - Come back in. The water"s fine! Yes, those brave investors are wading back into stocks. But the trend spotters expect the market to belly flop, possibly in a repeat of last summer"s bone-jarring dive.
Some experts say there could be a drop of some 30 percent that would drag the Dow Jones industrial average to the 7,800 level of last summer, when Wall Street was shaken by economic bloodletting in Asia, Russia and Latin America.
Many of the foreign countries whose sick economies dogged last year"s market are getting better, but the problem this time seems to be the exuberant U.S. economy. The world"s largest economy is so hot that the bankers at the Federal Reserve may want to cool things down.
In anticipation of the Fed"s move to raise interest rates, bond yields have jumped to the highest level in more than a year, standing above the psychological barrier of 6 percent. This is causing a lot of worries that the increased cost of borrowing will cut spending by companies and consumers.
Now, people are waiting for the other shoe to drop. It could come when the central bank"s interest rate-setting group has a two-day meeting on June 29-30.
The betting is that the Fed will hike the rates to take some froth off the steaming economy and head off inflationary pressures.
An interest-rate hike would highlight the overvaluation of the stock market, which some experts say has been priced out of this world vis-a-vis corporate earnings.
''Our study shows the Standard & Poor"s index is 40 percent overvalued, and a fair value would put it in the area of 1,000 and put the Dow around 7,400,"" said Don Hays, veteran chief investment officer for Wheat First Union in Richmond, Va.
Even Barton Biggs, the global strategist for Morgan Stanley Dean Witter & Co., repeated his opinion, which was first aired in February, that the Dow and S&P indices are over-priced and might have a 25 percent to 30 percent correction in store.
There"s a strange similarity between the market this year and last year.
''Stocks peaked this year at about the same time as last year, which was on May 12, when investors started to fret over signs the economy was slowing down,"" Hays said.
The market poked around for a few weeks after setting a high in May 1998, then it went into a freefall, with the S&P plunging 19 percent between July 17 and Aug. 30, pulling the index down from 1,186 points to 957. The collapse was just as dramatic for the Dow, which also plummeted 19 percent from 9,337 to 7,539.
Since then, the market"s biggest setback was a 5 percent skid in the first two months of this year, followed by another 5 percent slide in April and a 6 percent fall last month.
Nearly a year later, the Dow is cruising just below the 11,000 level with a gain of 15 percent for the year and the S&P hovers at 1,300, up 6 percent for the year.
But there are warning signs that the market is ripe for yet another nasty correction.
The bullish sentiment has topped 60 percent for the first time in 10 years, according to Investor"s Intelligence, a firm that surveys newsletter writers. Wall Streeters say it is a sign of trouble when too many stock investors think the same way.
''Usually, when you see sentiment that bullish, it"s time to become skeptical about every piece of good news, or at least become very intensive on investigating the real facts behind the news,"" Hays said.
''The earnings story is changing,"" he said. ''Tomorrow"s headlines will be that profit margins are down for the large companies that have been using accounting tricks to dress up their results,"" he said.
Companies have gotten bigger through mergers and their stocks have soared as they cut their overhead costs and fired the biggest number of workers in 10 years. But they"re now running out of answers to repeat the spectacular earnings of the last couple of years.
Investors may also be in for another dreadful surprise.
Arnold Kaufman, editor of Standard & Poor"s Outlook, an investment advisory letter, said the earnings of the 500 companies in the S&P index are expected to be up 15 percent or 20 percent in 1999 after being flat last year.
The biggest gain will come in the second half of the year, but there will be a lot of phony comparisons because the 1998 second half was a lousy earnings period due to the Asian crisis.
''Comparisons will look very, very good for the next two quarters, which will make it even trickier for Wall Street,"" Kaufman said.
Corporate profits of technology firms will be tougher to decipher because the sector will not benefit from last year"s special magic -- the sale of components to make hundreds of thousands of companies Y2K-compliant.
The Wall Street firm Donaldson Lufkin & Jenrette this week rattled personal computer makers and large software companies by pointing out that there will be a huge ''lockdown"" or cutback in technology spending as the date rolls over to the year 2000, when many computers may mistake it for the year 1900 or may not be able to function at all. Their bottom lines will be leaner in the fourth quarter.
Hays also said the market is no longer operating under the near-perfect climate because of a policy shift by the Federal Reserve.
During last summer"s global crisis, a panicky central bank rushed to build a firewall to protect the U.S. economy from the crisis in one-third of the world"s economy by flooding the system with money.
''The excess money was much more than the economy could stuff down, so it quickly spilled over into the U.S. bond market, driving the interest rate of the 30-year bond down to 4.7 percent,"" he said.
But the Fed has since taken the punch bowl away. The money supply, which grew at a tremendous pace of 12 percent last year, is now increasing at a snail"s pace of only 4 percent. And, over the last four weeks, the money supply growth has actually decreased for the first time in three years.
The money supply drain, which has caused the 30-year bond yield to climb above 6 percent, could make it tougher for stocks to make more headway
Hays recommends a defensive investment mix of 35 percent in stocks, 40 percent in bonds and 25 percent in cash for investors with a six-month to two-year outlook.
For the week, the Dow Jones industrial average was off 309.33 points at 10,490.51. The Standard & Poor"s 500 index fell 34.11 at 1,293.64 and the Nasdaq Composite index lost 30.46 at 2,447.88.
(Questions or comments can be addressed to Pierre.Belec(at)Reuters.Com)
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