Don't Expect a Bottom Until...
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Wednesday March 14, 5:16 pm Eastern Time
BusinessWeek Online
STREET WISE -- Don't Expect a Bottom Until...
By Margaret Popper in New York
<<If the stock market's dive on Mar. 12 caught you by surprise, you weren't alone. Sure, Cisco (NasdaqNM:CSCO - news) announced some bad news the previous Friday, but we all knew first-quarter earnings were going to be a bust. Or did we? Despite the swipes the bear is taking at the market on Wednesday, Mar. 14, lots of investor optimism is still propping up the stock market, many market watchers say.
Don't believe anybody can be optimistic after a slump like Mar. 12's? Look at Yahoo! (NasdaqNM:YHOO - news). Only a few days after CEO Timothy Koogle dropped his daily oversight duties and announced that earnings were going to be way lower than expected, the stock is still trading at more than 140 times earnings. Of course, Yahoo! doesn't represent the Nasdaq, or even the entire tech sector, thank goodness, but it's not the only company whose stock is still trading at an unjustifiably rich price-earnings ratio.
Valuation adjustments are still driving this market, more than problems with the economy or even corporate fundamentals. In fact, investor pessimism about valuations has spread from the tech sector to many of the Old Economy stocks in the Dow Jones industrial average. It's achieving crisis proportions, and before it's over, the Nasdaq could kiss 1350, a level not seen since 1998.
``NORMAL COMPANIES.'' Investors can't expect a bottom until the market has wrung out every drop of excess and values are too mouthwatering to pass up. Even a maestro like Federal Reserve Chairman Alan Greenspan can do only so much. Interest rate cuts won't fix what's ailing the Nasdaq. Only the continued piercing of puffed-up p-e's will do the trick.
``The market went to an extreme in valuation,'' says Harry Dent, president of the H.S. Dent Foundation, a money-management and advisory firm. ``The assumption was that all these companies were going to be the next Microsoft (NasdaqNM:MSFT - news). Now the market is deflating p-e's as if tech companies were normal companies and that's just what they are.'' The p-e ratio of the tech-laden Nasdaq to 12-month projected earnings currently rests in the low 40s, according to Thomson Financial data. That's still more than double the Standard & Poor's 500's 20 times 12-month projected earnings, but it's humbling when you consider the Nasdaq was trading at five or six times the S&P 500's p-e in 2000.
Tech stocks bear the guilt for this excess -- not unusual in times of huge technological innovation. In 1920 and 1921, the Dow fell 50% to 60%, says Dent. At the same time, unemployment reached 12%, its highest level in the U.S. outside of the Great Depression. What was ailing the markets and the economy? A shakeout in the automobile industry as dozens of car companies competed for what investors were beginning to realize was finite demand.
TWO LOSERS. Nowadays, Internet technology and telecom companies are watching their numbers dwindle, even as other segments prosper. In the year between March 10, 2000 -- the day the tech correction began in earnest -- and March 9, 2001, 9 of the 11 industrial sectors that make up the S&P 500 saw their stock prices rise, according to Steven Wieting, senior U.S. strategist at Salomon Smith Barney. Consumer cyclicals had the lowest appreciation, rising 6.5% during that period, while utilities stocks had the biggest increase, rising 45.3%. Only two sectors lost ground -- tech and telecoms, to the tune of 55.7% and 37.9%, respectively. But that was enough to lead the S&P into bear market territory.
The good news is the market could hit a bottom before March ends, Dent says. And he's not alone in this opinion. Indeed, most technical market analysts have reached the same conclusion. The bad news is the Nasdaq could revisit lows it hasn't seen since 1998, when the Asian financial crisis sparked a stock market meltdown. ``There is a lot of support around 1800 or 1850, but we can see it going as low as 1350 to 1400,'' Dent says. As was true in '98, global markets are interconnected, and the Nasdaq correction is reverberating around the world.
For that reason among others, market mavens believe the Fed will do what it can to stop any market slide from here. They point to recent history for proof. ``Greenspan has focused on the market as much as inflation,'' notes Dennis Ferro, chief investment officer at Evergreen Funds. ``In 2000, there was no meaningful inflation in the first half, but the Fed was concerned about asset inflation [inflated stock market values] and kept tightening.''
DECENT ECONOMY. The Fed's tightening through last May was one catalyst that helped squeeze excess out of the S&P 500 and the Nasdaq, according to Ferro. Now, he and others wonder whether the Fed may have gone too far and should have been easing more aggressively since Jan. 3, when it first cut rates a half percentage point.
Of course, Greenspan & Co. doesn't want to give the impression that it will jump to every note of the market's tune. Aside from plunging stock prices, which erased the vast wealth that was created from October, 1999, to March, 2000, the economy isn't in such bad shape. Unemployment is hanging in there around 4.2% -- near a 30-year low -- and the most recent data on nonfarm payrolls showed respectable job growth. True, retail sales numbers for February came in a bit lower than expected. But consumers had just gone on a buying spree in January when retailers cleaned house by discounting merchandise.
But what the Fed realizes is that the stock market's health is now inextricably linked with how consumers feel about the economic outlook. The central bank has to try to buoy stock prices so that consumers don't lose heart because they see their wealth shriveling like a raisin. ``Consumer confidence is affected by layoffs and the market,'' says Ferro. ``The Fed will cut a minimum of 50 basis points in March, and probably another 50 basis points in May, depending on what's happening with the stock market.''
WARNINGS AHEAD. Most analysts think we should be well out of the woods by then. ``Historically, the market bottoms 2 1/2 to 3 months after the Fed begins easing,'' says Charles Reinhard, senior U.S. investment strategist at Lehman Brothers. That would mean a bottom sometime before Apr. 3.
The S&P 500 has already corrected about 20%, not far off the average total correction of 18% when the economy manages a soft landing. Hard landings usually see corrections of around 24%, says Reinhard. So either way, by his reckoning we should be nearing the end of the market blues.
Even so, that doesn't mean earnings warnings are behind us. Normally, there is no glimmer of an earnings turnaround when the market bottoms, ``and the revisions continue for weeks,'' says Reinhard. Earnings typically bottom eight months after the market does, he adds. That's because the market is a ``forward-looking animal'' that is already discounting earnings nine months or more into the future.
But for at least the next couple of weeks, the market is probably going to continue telling us that the future looks pretty gloomy. Still, investors likely can take heart that we've seen the bulk of the correction and are lurching toward a bottom -- finally.>> |
