the more things change the more they remain....
August 15, 1982
Dark Days on Wall Street
By WILLIAM G. SHEPHERD Jr.
The last leg of a bear market is often crushing - a swift plunge in stock
prices on heavy volume that pounds small investors and institutions alike,
leaving them with big losses and shattered emotions. The effect can be
cathartic. But in the vacuum that remains, investors can begin rebuilding
their confidence. That last leg is exactly where the stock market now seems
to be heading. Indeed, it is hard to find anyone on Wall Street these days
who does not believe, or at least suspect, that the bear market is moving
into some sort of climactic phase that will purge the investment community of
its pent-up fears of economic collapse. In the past two weeks, all the market
averages have plunged to new lows as Wall Street, beset by cruel economic
news from all sides, has time after time been unable to mount a sustained
rally. That is a discouraging omen, an indication that the bottom has not
been reached, many securities analysts say, and a sign that even the most
steel-willed optimists may be about to throw in their towels.
''The market's going to take the ultimate dive to culmination in the next few
weeks,'' said James L. Freeman, director of research at the First Boston
Corporation, echoing the comments of many other market strategists. ''Batten
down the hatches.'' There is certainly good reason for pessimism. The Dow
Jones industrial average, battered by the protracted recession, a deepening
erosion of corporate profits and anxieties that brokerage firms as well as
banks are becoming increasingly vulnerable, slid 45 points in eight straight
days through Thursday before regaining 11.13 points Friday to close at
788.05. The average is down almost 25 percent from its peak in April 1981 of
1,030. Broader measures of stock market performance, such as the Standard &
Poor's 500, began declining even earlier - in November 1980. So far, the bear
market has cost shareholders $450 billion in losses. Though the consensus is
that the market is in for a tailspin, there is no clear idea on how to play
it and confusion seems to be the order of the day. ''Nobody can tell if the
we're starting a depression or ending one,'' said a mutual fund manager who
asked to remain anonymous. ''The market is one giant gamble.'' Many bulls -
while they concede that a sharp decline is likely - are acting on the
longer-term assumption that a boom is coming on the other side. They are
determined ''to tough it out,'' said Robert J. Farrell, chief market analyst
at Merrill Lynch, Pierce, Fenner & Smith Inc. It is just that group of
optimists, Mr. Farrell said, that must be driven to sell before the market
hits bottom. Mr. Farrell calls it a ''capitulation'' phase - a time when
everybody simply gives up. ''It doesn't have to be a lot of screaming and
100-million-share days,'' he said. ''It can be a disinterest in stocks and a
preference for something else.'' As Mr. Farrell figures it, a final sell-off
could come by November and maybe sooner. But a cardinal rule of the stock
market is that what most people expect usually does not happen. In 1974, when
panic selling was widely anticipated, one of the longest and most severe bear
markets ended in more of a whimper. The last leg of the bear market was
spread in relatively orderly fashion over nearly three months. The worst
market debacles - in 1929, 1962, and to a lesser extent in 1970 - have always
been those that caught investors off guard. The most recent example of
expectations betrayed has been the market's failure to react to declining
interest rates. Thoughout the spring and the first part of the summer, the
prevailing wisdom was that once rates began to come down stock prices would
shoot up. Short-term rates did begin to come down in late July, and since
then yields on three-month Treasury bills have dropped to 9.35 percent from
12.5 percent. But the market has continued its slide. This has utterly
confounded the theorists. The more agile among them quickly concocted two
explanations. One is that they meant longterm rates, which have not declined
yet. The other explanation is that credit is actually tighter now because the
jittery banks do not want to make any more bad loans. Barton M. Biggs, the
portfolio strategist at Morgan Stanley & Company, is probably closer to the
mark. ''I don't know what's going on,'' Mr. Biggs said in an outburst of
candor. ''The market's reading tea leaves.'' Even more disorienting is what
investors perceive to be the disarray in economic policy and the abandonment
of economic leadership in Washington: The inability of anyone to cut the
Federal budget, the flight of economic advisers from the Reagan
Administration, and most recently, President Reagan's sudden repudiation of
his own tax cuts in favor of a $99 billion tax increase. The proposed tax
increase is having an especially insidious effect. Bewitched by the
implications of large budget deficits and high interest rates, Wall Street
now has to worry about the proposed remedy, too. As if this were not enough,
the market has been buffeted in recent weeks by a sobering series of economic
developments: * The economic upturn is no where in sight. It did not appear
in the second quarter of the year, as many people had hoped. It does not seem
to be appearing in the third quarter, either. ''My analysts come back from
visiting companies,'' said John R. Groome, senior vice president in charge of
equity research at the U.S. Trust Company, ''and everybody's despondent. No
orders. No sign of an upturn.'' * Corporate profits are continuing to slide,
increasing the likelihood that companies will have to cut their dividends. A
recent Standard & Poor's survey of 885 companies found that corporate
earnings sank 16 percent in the second quarter following an 11 percent drop
in the preceeding three months. * Gulf's withdrawal of its bid for Cities
Service - and the subsequent collapse of Cities Service shares - did not just
produce huge losses for the professional arbitrage community; it also bashed
thousands of amateur speculators and a number of brokerage firms that had
risked their own capital in Cities Service stock. Coming on top of the
public's withdrawal from the market during the past year, which dried up
commission income, that blow has produced considerable alarm in the brokerage
community. * Another government securities firm, Lombard-Wall Inc, went under
in a smaller version of the collapse of Drysdale Government Securities Inc.,
which stung major banks last May. A small bank - Abilene National -closed its
doors within weeks of the demise of Penn Square. * The trouble is spreading
abroad. Following the mystery-drenched collapse of Italy's Banco Ambrosiano,
Germany's mighty AEG-Telefunken suddenly declared bankruptcy. Meanwhile, the
only rising stock markets left, in Japan and Britain, started falling -
suggesting that the slump is becoming worldwide. ALL this has led to
confusion and fatalism that is perhaps best illustrated by an ancient tale of
inevitability that John O'Hara made famous in a 1934 novel called
''Appointment in Samarra.'' One version of the tale: A man of Tabriz - call
him Ahmed the Sandalmaker - sees Death staring at him strangely in the
crowded marketplace. Terrified, Ahmed slips out of town unseen and flees to
Samarra, a city far to the north. Death, meanwhile, is puzzled. ''Wasn't that
Ahmed the Sandalmaker I saw in the market?'' he asks another man. ''Yes,''
the man replies.''Odd that he should be here, in Tabriz,'' Death says, ''when
I have an appointment with him tomorrow, in Samarra.'' What might be called
''Samarra anxiety'' is becoming a major undercurrent in the stock market as
more and more people, with their imaginations running wild, are drawing
parallels between current happenings and those just prior to the Great
Depression. Economic historians recall that when the economy turned down in
the early 1930's, Herbert Hoover considered cutting taxes as a stimulant. But
his economic advisers, on the grounds that a balanced budget was of paramount
importance, persuaded him to raise taxes instead. That decision is considered
one of the classic mistakes - along with the Federal Reserve's drastic
reduction in money supply - that led to the Depression. U.S. Trust's Mr.
Groome spoke for a great many professional investors last week when he said:
''To raise taxes during a recession is in my mind idiotic.'' The tax increase
might just turn out to be President Reagan's flight to Samarra. Considering
all that has happened in the past months it is astonishing that the market
has not fallen further. On average, bear markets since World War II have
lasted 15 months, and stocks have lost roughly 25 percent of their market
value. The current bear market is far longer in duration; now in its 21st
month, it is only a few weeks from surpassing the 1973-74 debacle. But so far
the decline has been comparatively shallow. The familiar Dow Jones average of
30 industrial blue chips, which peaked at 1,030.98 in April 1981, is down
only 24 percent. The broader-based indexes peaked late in November 1980, amid
the euphoria following Ronald Reagan's election. They have fallen further,
reflecting greater demolition among small stocks. The Standard & Poor's 500
is down 27 percent, while the S.& P. 400 industrials is down 29 percent. By
contrast - although the recession was not nearly so brutal -prices in 1973-74
fell 47 percent. Some ways of looking at the market, however, suggest that it
is on a par with the 1974 bottom. One yardstick is corporate earnings. When
the Dow Jones industrials hit 577.60 in 1974, their price/earnings ratio was
5.8. Today, with the Dow 200 points higher, the P/E ratio is only 6.5. The S.&
P. 400 industrials are lower than in 1974. Their P/E is currently 7,
compared with 7.2 in 1974. But virtually every professional investor believes
that Wall Street's earnings estimates are too high. ''The market didn't
anticipate how lousy earnings would be,'' said Ronald A. Glantz, who heads
investment strategy at Paine Webber Mitchell Hutchins Inc., and who has been
slashing earnings estimates drastically. If earnings do, indeed, turn out to
be much lower, the market would have to fall further to equal the 1974
bottom. A better yardstick is book value, which shows that today's market is
no higher than the darkest days of 1974. ''The S.& P. 500 hasn't sold below
book, and the Dow hasn't sold more than 20 percent below book since 1932,''
pointed out Morgan Stanley's Mr. Biggs. In 1974, the S.& P.'s price divided
by the book value of its component companies was 1.0 while the Dow's was 0.8.
Today the S.&P.'s is again 1.0 and the Dow's is a shade lower, 0.78. BECAUSE
the public has largely withdrawn from the market, trading has increasingly
been dominated by institutions. Thus, if high-volume selling materializes, it
may be the portfolio managers at bank trust departments, insurances
companies, mutual fund and pension fund management firms that will do the
dumping. That could set the stage for a repeat of the 1970 plunge. In that
bear market, it was the professional who panicked and the muchmaligned
''small investors'' who, to everyone's astonishment, moved in to buy at the
bottom and to stem the decline. Wall Street likes to look on the public as
naive and likely to be wrong most of the time. But the fact is that when it
comes to the mysteries of the marketplace, the professionals can be as wrong
as anybody. Thus, it is interesting to speculate what the public might do.
Joseph Granville, a flamboyant market-letter publisher who has a wide
following among amateur investors and is heartily disliked by the Wall Street
establishment, correctedly called the market's top late in 1980. In his most
recent published interview in the newsletter Bottom Line, Mr. Granville
stated that he expects the Dow to bottom between 550 and 650 by January. He
then foresees a rally of 200 to 300 points, possibly followed by another
steep decline. Merrill Lynch's Mr. Farrell also wields a great deal of
influence among small investors, as well as professionals. His view is more
temperate.''I've been saying for a long time that it could go to 700 or to
the low 700's,'' he said. ''When people start saying, 'Why stop at 700? Why
not 600, or 500? - when the risk seems open-ended - that's when the bottom
will occur.'' Mr. Farrell believes that the bottom may be only two or three
months, and perhaps only one month, away. Beyond that, though, he is strongly
bullish. ''Once you get through this critical period, say the next six
months,'' Mr. Farrell said, ''I believe you really will see the start of the
Great Bull Market of the 80's.'' William G. Shepherd Jr. writes about finance
from New York. |
