This bear market isn't normal, some experts say
By GAIL MARKSJARVIS
St. Paul Pioneer Press
ST. PAUL, Minn. - Confusion reigns.
Wall Street's strategists are involved in a heated debate, with the majority arguing that stocks are now about 20 percent undervalued and positioned to rally once investors start seeing improved corporate profits - evidence that should start appearing as earnings reports are released over the next few weeks.
But with the stock market below Sept. 11 lows, fear is mounting, and it's stoking the other side of the debate - that this is not your normal bear market.
Typically, run-of-the-mill cyclical bear markets take the stock market down about 28 percent to 30 percent and are over in about 18 months, according to historical research by the Leuthold Group, of Minneapolis.
Yet this bear market is already almost 2-1/2 years old. The Standard & Poor's 500 has fallen about 45 percent, and the Nasdaq has lost about 73 percent. Meanwhile, there is growing concern that phony accounting has blurred the true state of corporate profitability for some time, and that the market could take a long time to adjust to a more accurate and subdued picture.
Some analysts are starting to call this "a secular" bear market - the worst kind of extended bad periods for investors. In secular bear markets, there are occasional rallies, such as the 300-point upswing that occurred the day after the Fourth of July - apparently a relief rally when there was no terrorist attack.
But despite such rallies, these bear markets linger, quickly erasing gains from tricky rallies, and testing investors' nerves day in and day out.
Investment managers who lived through the secular bear market in 1973-1974 frequently describe those days as Chinese water torture - where the hope of each rally is replaced by more losses, and the disappointments make it tougher and tougher to come to work each day.
But as veterans of that period, they also remind investors that even though secular bear markets feel as if they will never end, relief eventually does arrive. With time, stock gains replace losses. After a drop of 48 percent in the market in the early `70s, for example, investors eventually were made whole again, although it took 7-1/2 years. Even though the secular bear market of 1929-1932 ushered in the Great Depression, investors since then have enjoyed returns averaging 11 percent a year.
Minneapolis market strategist Steve Leuthold, of the Leuthold Group, is among those veterans. He thinks investors currently are in the midst of a secular bear market.
"But the good news is, I think the current secular bear market is approaching the end," he says.
Using history as his guide, he notes that the current bear market has been under way for 830 days, slightly less than the 900-day 1929-1932 bear market and longer than the 700-day 1973-1974 trauma. Arguably, however, the market then had troubles for a longer time. Leuthold said it could be dated back to 1968 - or a 2,100-day bear market.
He notes the Nasdaq's 73 percent decline is close to the 75 percent decline in the Value Line (aggressive) Index from 1968 peak to 1974.
Generally, secular bear markets follow periods of aggressive investing, or speculation, that come to an abrupt end - like the popping of a bubble. These periods pump too much money into unworthy new businesses.
So there are great excesses to correct, too much competition, too many products and capacity, and consequently an inability to charge enough for a decent profit. With time, overcapacity is worked out of the system, but along the way businesses fail and stock prices fall.
After the Roaring `20s, the then aggressive Dow Jones industrial average fell 89 percent from 1929 to 1932, notes Leuthold.
While Leuthold thinks the current bear market may be close to over, he says large-company stocks are still vulnerable because they remain expensive by historical standards and could be hurt if investors make major changes in their investing habits.
In particular, he would be concerned if investors dump index funds in large numbers, and if pension funds seek security in bonds and alternative investments, while pulling money from stocks.
Investors pulled $2.7 billion from index funds in June, and $20 billion from all stock funds, but Leuthold notes the redemptions so far have been light compared to 1987 market crash.
Meanwhile, Morgan Stanley strategist Steve Galbraith thinks the pessimists have been overreacting - taking on the opposite stance of the late 1990s.
Then, at the speculative peak in the market, investors borrowed money to invest in stocks. They fought to get into IPOs that rose 100 percent a day, and believed ridiculous business plans that suggested young, flimsy companies were appropriately priced with market values that exceeded small countries' gross domestic product.
Now, he says, those very investors are saying, "The end is nigh." They are ignoring the "above expectation profits" at companies as diverse as Wal-Mart, DuPont, 3M, Dell and MBNA.
"Picking tops and bottoms of markets is a fool's game," says Galbraith. "We don't have a clue when the carnage will end."
But, he says, "We have gone far in wringing out the speculative portion of returns." Stocks, as measured by a valuation model constructed by the Federal Reserve, "have fallen to their lowest valuation in Greenspan's tenure."
Robert Pelosky, a Morgan Stanley global strategist adds, "What has changed is the universe of stocks where we can now say, with a straight face, that the multiples can hold and earnings should grow sufficiently in concert with dividends to afford investors double-digit returns. In fact, around 130 of the companies in the S&P 500 now trade at 17 times 2003 earnings or less, and yet are forecast by the consensus to post double-digit earnings gains in the near and long terms."
But attractive stock values alone haven't been able to move fearful investors. Geopolitical threats are still real, more accounting upsets are likely, corporate profits are still unproven, and the economy is recovering more slowly than expected, and therefore many money managers are telling investors to be cautious about risking new money in the market. But they also are not suggesting that investors flee the market either.
Martha Pomerantz, a money manager with Minneapolis-based Lowry Hill, says she is keeping as much as 15 percent of some clients' portfolios in cash - both as a precaution and to have money available when she feels more confident about buying additional stocks.
During the last few months she has diversified portfolios more than in the past, by adding more bonds, a variety of real estate investment trusts, and cutting back on large-cap stocks. And she has broadened the stock portfolios so they now include a number of somewhat boring, high quality companies that are smaller than the mega caps - companies such as United Technologies, UPS and Washington Mutual. She added companies that have good cash flow and a little dividend yield.
Dividends could be significant parts of overall returns if stocks don't climb much over the next few years. Many market strategists are telling investors not to expect returns over 5 or 6 percent annually for the rest of the decade, and that return includes dividends.
Foreign investors, seeking better returns and skeptical of the U.S. accounting that was once touted as the world's best, have withdrawn money from U.S. stocks and invested in other parts of the world. With their change in attitude, the U.S. dollar has also fallen about 15 percent compared to the European euro.
"We are worried about the dollar," says Pomerantz. She thinks the loss of foreign investors has been a major reason why large U.S. company stocks have fallen so much.
Likewise, Michael Wright, a St. Paul, Minn.-based money manager, says before deploying new money in the stock market, he wants to see the dollar get stronger. With mutual fund investors pulling money from funds lately, he thinks it's important that foreign investors stay invested in U.S. stocks.
Over the next four to five weeks "it's not a bad idea to hold cash," Wright notes. Within that time period, he thinks investors will see more clearly how the economy is growing, whether corporate profits are improving and if the U.S. is invading Iraq.
Sue Stevens, a Deerfield, Ill., financial planner, agrees that this is no time for taking chances.
"This is not just about companies recovering and cleaning up accounting scandals," she says. "It's that we live in a time when all of us think terrorism could happen. This is a different kind of damper - it's a wild card. And if we don't see anything happen for awhile, the market could go up a lot. But if we attack Iraq, it could go the other way."
So she called each client a couple of months ago, and said: "I want you to be prepared for the possibility of not so happy years to come - a time when bonds may be the heroes for a few years."
She wanted clients to keep money in the stock market so they would be positioned for a rally, but she also wanted them exposed to no more risk than they could handle if the market continues to be down or flat for some time.
For many clients, that meant taking about 10 percent out of their normal allocation of stocks and putting 10 percent more into bonds. So a person, who normally had 60 percent in stocks, moved to 50 percent.
For some seniors well into retirement, she made sure they retained two years of cash, possibly 25 to 30 percent in stocks, and enough short-term bond investments so that she could move back into stocks when the market improves.
For people in their 20s or 30s, she still thinks 80 to 75 percent in a well diversified stock portfolio is fine for retirement. But college savings are a different matter because they could be hit hard and not recover enough before children go to college, she says.
Right now, she advises clients not to use the normal allocations in 529 College Savings Plans, which are adjusted on the basis of a child's age. Instead of age, investors now must be aware of the possibility of a lackluster or down market for some time and invest less college money in stocks than they may have previously.
As a rule, investors should not place any money in stocks or stock funds if it will be needed for college, a house down payment or anything else within five years.
For investors who haven't already taken precautions, Stevens says it's not too late. Investors who are heavily invested in technology and growth - especially those in their 50s and approaching retirement - should diversify retirement savings now.
"I've had tearful moments in meetings with people in their 50s, who have lost 30 percent or more," she says. "As you approach retirement, preserving principal must be more of a concern."
Still, for people nearing retirement, she would keep about 50 percent of investments in a blend of stock funds. The portfolio would include 60 percent large caps, 20 percent mid-caps and 20 percent small-caps. And in each category, she'd place 65 percent in value funds and 35 percent in growth funds. Among the funds she likes are Dodge and Cox stock, Dodge and Cox balanced, Oakmark equity and income and Royce Special Equity.
For people who have lost a great deal of their retirement nest-eggs, she reminds them that they may be better positioned than they think because their homes have probably appreciated greatly. The equity can be freed up in retirement, she says, by moving to a smaller home. |
