WSJ/Money & Investing: Investors Expect Rally to Stall Before Gaining Bull Territory
November 19, 2001
By SUZANNE MCGEE
Staff Reporter of THE WALL STREET JOURNAL
The Dow Jones Industrial Average, the stock market's blue-chip bellwether, is only 16 points away from a 20% gain off its recent low point, an event that would technically push the index into bull-market territory.
Too bad few people in the market are convinced the rally is going to hold.
"I can't remember seeing a market advance that people trust less than this one," says Douglas Cliggott, U.S. stock market strategist at J.P. Morgan Securities. Mr. Cliggott numbers himself among those skeptics, betting that by the time winter sets in, the market will start giving back its gains of the past two months.
The skeptics point to an assortment of lingering problems, including price-to-earnings ratios that remain too high, corporate earnings that are too low, and the possibility of more terrorist attacks or a military quagmire in Afghanistan.
Still, traders believe that despite a tiny setback Friday, when the Dow Industrials retreated 5.40 points to 9866.99, the market benchmark could still easily break above 9882.97. Once it does, it will have rallied 20% from the Sept. 21 low of 8235.81, making it, by the most-common definition, the first new bull market in more than a decade, according to calculations by market-research firm Birinyi Associates in Connecticut.
Of course, these are only technical calculations, ignoring that both the Dow Industrials -- and, more frequently, the Nasdaq Composite Index -- have seen a number of brief rallies in the past 18 months, only to have those gains evaporate. Currently, for instance, the Nasdaq composite is up more than 30% from its postattack lows -- the latest in a string of recent sharp run-ups -- though few traders expect it to last.
Since World War II, there have been 10 "true" bull-market debuts, defined as 20% gains that come on the heels of 20% declines. Only one of those has been followed by negative returns for the three months and year following the initial break into bull-market territory. In the other cases, returns ranged from 0.39% in the three months following the 1990 bull market to 16.87% in the three months following that turning point in 1976, and between 1.44% in the year following the 1968 bull market and 37.26% for the year after the 1976 jump.
But many skeptical investors and analysts say that, in this case, history is no guide. "We've seen most of the gains we're going to," says Michael Clark, head of stock trading at Credit Suisse First Boston. The chance of a break above 9882.97 being followed by an extended bull market in the Dow Industrials? "I don't see it happening," he declares.
Nor do many other market participants, who scoff at the current rally as nothing more than a bear dressed in bull's clothes. "If you believe today's market, which is doing better than it was on Sept. 10, then you have to believe that things are actually better today than before" the terrorist attacks, says George Jacobsen, chief investment officer of Trevor Stewart Burton & Jacobsen, a New York investment-management firm. "People seem to want to believe that things are getting better, but can you really make that strong an argument?"
Some investors say they don't want to get blindsided again, as happened when the springtime rally sputtered to a halt. Investors attribute that reversal to the realization that corporate earnings and the economy wouldn't show the signs of recovery that bulls had been betting on when they drove major market indexes higher. Many say the latest batch of bulls may face a similar epiphany early in the new year, igniting another selloff.
When Can a Bear Pass for a Bull?
When an index rises 20% from its most recent low, it is, by a Wall Street rule of thumb, in a bull market. But, if the Dow Jones Industrial Average hits a 20% gain (it has now gained 19.8% since its Sept. 21 low), not everyone is convinced it's a lasting bull. Below, how the average performed in the three months following each of these bull-market periods.
BULL MARKET (Market bottom to top) % CHANGE DURING BULL MARKET RETURN ACHIEVED THREE MONTHS AFTER THE INITIAL 20% GAIN
April 28, 1942 – May 29, 1946 +128.7% +7.8%
June 13, 1949 – Dec. 13, 1961 +354.8 +5.4%
June 26, 1962 – Feb. 9, 1966 +85.7 +6.0%
Oct. 7, 1966 – Dec. 3, 1968 +32.4 +1.1%
May 26, 1970 – Jan. 11, 1973 +66.6 +1.3%
Dec. 6, 1974 – Sept. 21, 1976 +75.7 +16.9%
Feb. 28, 1978 – April 27, 1981 +38.0 –10.2%
Aug. 12, 1982 – Aug. 25, 1987 +250.4 +7.7%
Oct. 19, 1987 – July 16, 1990 +72.6 +0.4%
Oct. 11, 1990 – Jan. 14, 2000 +395.7 +3.0%
Sept. 21, 2001* – ? ?
*Start of a new bull market only if the DJIA completes its 20% gain
Source: Birinyi Associates
"People are making the same mistakes they did [earlier] this year," says Scott Schermerhorn, co-head of value investing at Liberty Funds Group, a FleetBoston unit. "This rally is unstable and precarious."
Still, some market participants, regardless of their convictions, are behaving as if the rally will turn into a long-running bull market.
Hedge funds, which have reaped rich rewards by betting on a declining market for most of 2001, are now trying to protect those gains by covering short sales. That means these sellers have now become buyers and are adding juice to the rally. Institutional money managers are fearful of being left on the sidelines in case the rally does develop into a big bull run.
In the bond market, last week's selloff suggests that fixed-income investors are beginning to embrace the view that an economic recovery may be closer than they once expected. Economic news "came in more strongly in favor of the stock market's view, and the bond market adjusted sharply in that direction," says Peter Hooper, chief U.S. economist at Deutsche Bank. "It is too early to declare the recession over, but we cannot deny there is a more optimistic feeling in the air."
But there are few optimists among the ranks of stock investors, who should be among the biggest beneficiaries of a stronger economy. They fret that the economic signals -- stronger retail sales, lower jobless claims -- are misleading, and point instead to the difficulties that bellwether technology companies and other key corporations have in predicting any kind of improvement in their operating environment. Trouncing the Taliban won't resolve the terrorist threat, they fear. Above all, they point to the stock market's still-lofty valuations as a compelling reason why any gains may be short-lived.
"Going back through history, we can't find another example of a market bottom that was reached at such high valuations as that of Sept. 21," argues Mr. Cliggott. According to his calculations, on Sept. 21, the Standard & Poor's 500-stock index components traded at 34 times net income for the most recent 12 months. In past market bottoms, that valuation hasn't topped 16.5 times trailing net income, Mr. Cliggott adds. Today, he notes, the market is valued at a whopping 40 times trailing earnings. That means that even if the rally continues, "people are going to have to really restrain their expectations and not jump into the market at these levels expecting double-digit returns."
Even those who argue that what's looming on the horizon is indeed a bull rather than a bear in disguise admit that the animal in question is a particularly runty specimen.
"If we cross the threshold, we're still going to be in dangerous territory," says Jeff Rubin, head of research at Birinyi Associates. He notes that the crash of an American Airlines jet in New York last Monday morning sent the Dow Industrials down sharply on fears that the tragedy may have been caused by terrorists.
"This is a fragile bull market," Mr. Rubin adds. "We don't recommend that anyone jump in head first. You've got to wade in and pick your investments very carefully."
-- Gregory Zuckerman and Ken Brown contributed to this article.
Write to Suzanne McGee at suzanne.mcgee@wsj.com1
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