Time to Climb Out of Street Trenches?
Sunday, April 15, 2001
By Pierre Belec
<<NEW YORK (Reuters) - There's a distinct feeling of "once burned twice shy" among most Wall Street bulls who have been hiding in the trenches during the market's butchering. But lately, more investors have been willing to jump back into stocks on signs the deep market correction may be over.
Are stocks headed onward and upward? Listen to what experts say.
"The lower they go, the closer the ultimate bottom and next important buying opportunity," says James Dines, editor of the Dines Letter, an investment publication. "Bullish factors are beginning to accumulate such as increasing pessimism. Interest rates are coming down, a tax cut might be in the offing, leading cyclicals like General Motors and Ford are trying to run up even on bad days."
There's a logic behind this mentality.
Investors find it much easier to trade a bull market than a bear market. Typically, traders are tradition bound, and, usually, are not very imaginative or creative, which explains why they will always buy stocks first, and then sell them. It's just a natural sort of thing.
They also believe that uptrends can last forever, allowing for brief pit stops for the market to refuel.
Also, investors tend to be optimistic and find it hard to give up love affairs with old flames. Some are still dreaming of replaying for the next 20 years the incredibly rewarding bull market in technology stocks that produced an incredible gain of 87 percent for the Nasdaq in 1999.
But history shows that yesterday's market leaders don't always come back for encores after they've had their 15 minutes of fame. Natural resource stocks, for example, were hot in the 1970s. Then in the 1980s it was the consumer stocks' turn. Seen any mania lately for those old shooting stars?
EASY SIGNAL OF MARKET BOTTOM
How in this scary world of investing can people decide when a happy market recovery will start? Watch the margin debt. It's a pretty good long-term indicator.
The explosion in margins -- something that's used by speculators who buy stocks on credit -- was the high octane that fired up the market's moonshot ascent. The bulk of the cash went into the Nasdaq market, which is dominated by volatile technology and Internet stocks.
So it would make sense that during the unraveling of the bull market, the margin debt would have to work itself back down to where the bull market's run first started. Trading on margin requires people to put 50 percent of their cash down and borrow the other 50 percent to trade.
The debt owed by the brokerage houses' customers has fallen by 33 percent to $186.8 billion from an all-time high of $278.5 billion in March 2000 when the Nasdaq peaked at 5,048.62, says the New York Stock Exchange. What has happened is that traders who were mortgaged up to their eyeballs were forced to sell their positions as the market crumbled. It's referred to in Street lingo as "getting a margin call," a numbing and humbling experience.
Indeed, the popularity of trading on margin has exploded. In 1995, when Americans were married to the market as it started to chalk up double-digit gains each year, margin debt was only $60 billion.
NASDAQ CRASHES, MARGIN DEBT SHRINKS
While the Nasdaq market has crashed, the customers' margin debt has gone down at a much slower pace. The Nasdaq composite index is down a stunning 65 percent from its high while margin debt has retreated by some 33 percent from its peak.
Perhaps the best bet for investors with low market expectations is to wait and see if margins retrace most or nearly all of what was built up during the bullish mania. If it does, people might see it as an all-clear whistle that a market bottom has arrived.
"If the Nasdaq flips back down by another 300 points, we could see a huge amount of margin calls," says Ned G. Riley, chief investment strategist for State Street Global Advisors, with $680 billion under management.
"But what has probably happened is that, discreetly, brokerage houses have tried to get a lot more cash into their customers' accounts and use more securities to back up the margined stuff," he says.
The Street has known for some time that the explosion in margins did a lot to create one of the greatest market hysterias in history. So it's inconceivable that the brokerage industry would have stood by and done nothing over the past year of market turmoil to get their delicately balanced customers' accounts up to snuff.
WALL STREET'S LESSON
Stock speculators have learned that it is always wise to understand the rules before they take a stab at gambling in the market. They also discovered the market always comes down faster than it rises because money has a habit of running out of stocks faster than it runs in. Call it the law of gravity.
"A number of Wall Streeters over the last two years couldn't believe what we were seeing in the market but the truth was that it was happening and therefore, this levitation, lunacy and lemming syndrome as stock prices soared, was real," says Riley.
"Now we're seeing just the opposite," he says. "Many people are frozen and they have no confidence in the market with corporate earnings prospects having fallen into a deep hole."
Kent Engelke, capital markets strategist for Anderson & Strudwick Inc., expects stocks to rally but the question is whether the upturn will be sustainable. The key will be how the companies view the future, i.e. "forward looking statements" as they report their earnings this month.
The betting is that Corporate America will continue to paint a lousy picture about the next two quarters.
"The equity markets reflect expected business conditions six to nine months into the future," he says. "The news will get worse before it gets better, but the market may be already around a bottom."
More investors have shaken off their worst fears -- a creeping crash that constantly eats away at the market's foundation.
TIME TO TALK REWARD VS. RISK?
"Two years ago, the word 'risk' was not mentioned but now everyone is talking about the risk of this and that, but I say that this is the time when people should be talking up the word 'reward' versus risk," says Riley.
"If anyone still believes there is a downside potential of up 5 to 10 percent after the freefall we've had, I think it's time to ask: 'What is the upside potential?' If it's 30 to 40 percent, then those are the kinds of probabilities and odds that I like to deal in," he says.
Stocks rebounded this week with the Dow Jones index clawing back above the magical 10,000 level for the first time since March.
The Dow is less than 20 percent from its high, having escaped the clutches of the classic definition of a bear market. The Standard & Poor's 500 index has slumped nearly 30 percent from its peak.
But the Nasdaq index is still struggling after a bone-jarring drop of 65 percent from its March 2000 high. The Nasdaq's plunge is remarkably similar to the brutal 65 percent drop in the Japanese Nikkei stock index from its December 1989 high of 38,915. The Nikkei now hovers at 13,352 more than a decade after Japan's speculative bubble burst.
So far, most rallies have been wet firecrackers or bear-traps that have sucked in the "permabulls" who believe the risk of being out of the market is greater than being in, despite the gloomy fundamentals of a slowdown in the U.S. economy and corporate earnings.
Sometime in the next few weeks or months, investors will get a second crack at the next bull market, though the run-up probably won't create the same stock valuation abuses seen between 1995 and 1999.
For the holiday shortened week, the Dow Jones industrial average was up 336 points at 10,126. The Nasdaq composite index gained 241 at 1,961 and the Standard & Poor's 500 index rose 55.07 at 1,183. The market was closed on Good Friday.>>
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