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Investors Wait to See If the Rally Is Real
Past Bear Markets Suckered Plenty Into Thinking the Bottom Had Been Reached
By Ben White
Washington Post Staff Writer
Sunday, July 28, 2002
NEW YORK -- Ask Art Cashin about the stock market "sucker rally" of 1973 and the pain in his voice will convince you that it happened yesterday.
Cashin, then a low-level broker at New York Stock Exchange, recalled the fever that seized traders who snatched up thousands of shares because they were certain that the slow, merciless decline that began in 1972 was over. But the rally was a mirage. The Dow Jones industrial average bled to a new low in 1974. It took eight more years to make up the losses.
Investment adviser Daniel Turov, meanwhile, helped his clients make fortunes in that time. Using proprietary models of investor emotion, he called the bottom in a 1974 article in Barron's headlined "Buy Signal," and told readers of his newsletter that the time had finally come to scoop up stocks on the cheap. Twenty-six years later, he called the market's peak as well.
So where are we now? Was Wednesday's 490-point Dow surge another sucker rally? Or have we finally hit the bottom and bounced? No one knows, of course, but Turov, for one, is not convinced.
Several market professionals and Wall Street historians -- Cashin, who now runs floor operations for UBS Paine Webber, among them -- do think Wednesday's advance at least signaled that the worst could be nearly over for "old economy" stocks in the Dow Jones industrial and the Standard & Poor's 500 stock indexes.
Not so the Nasdaq Stock Market, which, unlike the Dow, gave back nearly half its Wednesday gains by the end of the week. Many believe that the telecommunications and technology companies that dominate the index have farther to fall to finish a collapse now nearly as big as, and eerily reminiscent of, the 1929 Dow crash. The Dow did not overtake its pre-crash high until the Eisenhower presidency.
"The 1920s were a lot like the 1990s, and the 1930s were similar to what we are seeing now," said Richard Sylla, a market historian at New York University's Stern School of Business. "Of course, the bottom hasn't fallen out of the economy as it did then, and you don't have a run on the banks.
"But the '20s had the same mania for new technologies, like radio and movies. And three years after the crash you had nasty stories about fraud and congressional hearings. . . . You even had the heads of what are now J.P. Morgan Chase and Citigroup dragged to Washington in disgrace to testify," Sylla said.
Representatives of both banks appeared before Congress on Tuesday to explain the work they did for Enron Corp.
As of Friday, the Nasdaq was off 75 percent since its high of March 2000; the Dow lost nearly 89 percent from its peak in 1929 through its recovery in 1954.
In remarks echoed by others, Robert J. Froehlich, chief investment strategist at Deutsche Bank Asset Management, said the bubble in the late 1990s was like none other. He predicted that the Nasdaq will take years to recover.
"In 1996 you had the Telecommunications Act that deregulated the market and everyone tried to upgrade equipment to take market share," Froehlich said. "You had the launch of the common currency in Europe and an amazing technology boom to get ready for that; the great tech buildup to Y2K; the boom in the Internet where everyone was using it but nobody knew what it meant; and the explosion in wireless technology. . . . No one had ever seen anything of that magnitude and it will take more time for that sector to get back to reality."
But Froehlich and other Wall Street strategists suggested that the Dow and the S&P 500 index may begin steady recoveries within the next several months. Cashin, for example, said that heavy volume and wild fluctuations typify late-stage bear markets. The New York Stock Exchange set volume records twice in the past few weeks and pogo-stick days with swings of several hundred points are common.
"The lore of Wall Street is that rallies in late bear markets are deceptively sharp and short," Cashin said.
Sylla said he expected to see a "W-shaped" recovery for the market similar to the one created by the "sucker rally" of 1973.
"If good corporate news comes along I would not be surprised to see some more decent bear-market rallies, followed by a retesting of the lows," he said. "If we don't go below those lows, then we could be setting the stage for a sustained recovery."
Historic data, though, indicate that big-company stocks still have to fall more to get in line with previous norms. According to Ibbotson Associates, from 1926 to now the average price-to-earnings ratio for the stocks that make up the S&P is 14.02. The S&P is currently trading at 30.26 times trailing earnings, according to Bloomberg -- though that number could go lower if corporate profits continue to recover.
Optimists suggest that the underlying economy and general investor sentiment could support a ratio at least somewhat higher than the historic average.
"Current valuations are very sustainable," Froehlich said. "We have very supportive monetary policy, we have inflation at 1 percent going down to zero, we have strong productivity gains, we have companies that have cut their costs and we have improving profit margins."
Froehlich said he does not accept the argument that falling stock prices will knock out consumer spending, snuffing out the recovery in corporate profits. He said data show that consumers tend to increase spending based on the rising value of their homes more than they do based the performance of their stocks. So rising real-estate prices should prop up spending.
He suggested that retail stocks such as home-improvement and appliance stores would do well in a recovery because of the strong housing market. And he said defense stocks would continue to prosper based on the uncertain geopolitical environment and the consistent threat of further terrorist attacks.
Perhaps adding further credence to theories that the current down cycle might be ending, both the Dow and the S&P have shed amounts roughly typical of recent bear markets. According to Ibbotson, the Dow lost an average of 30 percent in the past five bear markets, defined as a loss of at least 20 percent from a previous peak. As of Friday the Dow was off almost exactly 30 percent from its January 2000 peak. The S&P lost an average of about 29 percent over the past five bear markets; as of Friday the S&P was down 44 percent from its March 2000 high.
But for every Froehlich there is a skeptic who views most stocks as still grossly overvalued and the underlying economy as shaky at best. Short-sellers, professional investors who make money betting that stock prices will drop, are prominent in this group, perhaps in part because they stand to gain if people believe what they say and act on it.
Bill Fleckenstein, a Seattle-based short-seller, predicts "10 years of yuck" ahead.
"We've just come off the biggest mania in the history of the world when the Federal Reserve became completely incompetent . . . allowing people to suspend disbelief and think the market could go nowhere but up," he said. "That's all unwound now and the whole world gets the joke and we have hell to pay."
"If I had to guess," Fleckenstein said, "I'd say at some point we will have another big rally, then that will fizzle and we will go down some more and then finish lower for the year than where we are now."
He said he thought 2004 might be a good year to start buying stocks again.
Some academic observers suggest that the current bear market illustrates the weakness of the oft-repeated argument that stocks are always the best long-term investment and that buying and holding a diverse basket of equities will guarantee strong returns.
"This is simply not true; logically it cannot be true. There is always a level of uncertainty involved," said Henry T.C. Hu, a professor of corporate and securities law at the University of Texas at Austin and author of a 2000 article that suggested federal policymakers have too strongly promoted an equity culture. "If it were true, in a sense, then everyone in the world should be 100 percent invested in stocks. . . . And I really disagree with that. There is always an element of risk."
Turov expects to see a sideways market persist for years to come, with intermittent rallies and declines. "I would not be surprised if in 20 years from now the Dow is in the same place it is right now."
© 2002 The Washington Post Company
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