More Investors Buy In to Rally As Bears Begin to Grow Horns
Low Rates, Possible Tax Cut Lift Optimism; Doubters Cite Year-Ago Rocket That Fizzled
By E.S. BROWNING / WSJ May 19, 2003
A few weeks ago, Hank Herrmann wasn't making big bets on the stock rally's future.
Mr. Herrmann, who oversees investment policy at mutual-fund group Waddell & Reed in Overland Park, Kan., didn't think there was enough oomph in the economy to keep the rally going. As a result, he vowed to keep 10% or more of his assets out of the stock market, just in case stocks went lower.
Not any more. Today, Mr. Herrmann is feeling unusually bullish. He has been buying stocks like oil and gas companies and home-improvement retailer Lowe's, all of which he thinks will benefit if the U.S. economy starts to rebound.
What changed Mr. Herrmann's mind? With bond yields and other market interest rates plummeting, with the Federal Reserve committed to keeping them down and with Congress seemingly ready for tax cuts, he has decided that the economy is going to stay out of recession. That, he thinks, means stocks should stay up. "We are putting things in place and starting to have some success" with economic policy, he says.
At investment firms across the country, a similar kind of conversion is taking place. While few professional investors expect a soaring, 1990s-style bull market, many of the professionals nevertheless think things are looking up. Even if they don't know how long the rally will last, they want to get into stocks as fast as they can.
Last week, the Dow Jones Industrial Average eked out its third consecutive week of gains, rising an additional 74.37 points, or 0.86% to 8678.97, despite a decline of 34.17 points, or 0.39%, on Friday. The industrial average has risen almost 1,400 points, or 19%, since it hit a five-year low on Oct. 9, and other indexes such as the broad Standard & Poor's 500-stock index and the Nasdaq Composite Index have risen even more.
By the standard Wall Street definition, stocks went into a bull market during the October rebound, when all the main indexes were up more than 20% from their Oct. 9 lows. They are behaving a lot like they did a year ago, when they surged in the autumn and then tried to surge again in the spring.
Last time, they ran out of steam and sagged. Given that history, it isn't surprising that some investors think the recent gains have come too fast and that the market is overdue for a temporary pullback. Many fear that, in the longer run, the current bull swing is a temporary phenomenon that will run out of steam entirely. If the economy falls into recession or if another serious terrorist event occurs, they say, stocks eventually could fall to new lows.
Still, this spring rally is proving a lot stronger than it did last year, leading some experts to hope that the gains could last longer.
Bridgewater Associates, a money-management group in Westport, Conn., that oversees $38 billion in investments, has long been about as skeptical as Mr. Herrmann. But last week it published a bullish analysis calling the current situation a "grand slam" for financial markets.
It listed these positives: Bond yields and other market interest rates are falling, including rates for corporate bonds, which should help stimulate the economy and reduce the weight of the debt burden on companies and individuals. (On Friday, in fact, the yield of the 10-year Treasury note fell to yet another 45-year low, 3.451%, meaning fixed-rate mortgages, which generally are pegged to that yield, could fall to record lows this week.)
The dollar has fallen, boosting profits for U.S. multinational corporations. Commodity prices have fallen, including the price of oil, reducing costs.
"The current mix of financial conditions gives the most hope we've had in a long time, for at least a short-term significant bounce in growth," Bridgewater concluded.
On top of that, with almost all the companies in the S&P 500 reporting their first-quarter results, earnings were up about 12%, well above the 8.5% gain that was forecast, according to Thomson First Call, which tracks corporate earnings and analysts' forecasts.
Yet, even some of the optimists aren't sure how much they believe it. Since stocks peaked and began their long decline more than three years ago, investors have seen repeated rebounds, none of which could be sustained. A study by Ned Davis Research indicates sharp stock gains of 20% or more within short periods of time are typical of long bearish periods, and often are followed by renewed declines.
According to conventional market wisdom, any 20% surge in a major index classifies technically as a bull market. But analysts draw a distinction between a "cyclical" bull market -- a temporary one -- and a "secular" bull market, one that continues, with brief pullbacks, for a period of many years.
Some analysts fear the current bull market will prove to be one of a short-duration in the midst of a longer-running bear market -- the kind of temporary bull market sometimes referred to as a "bear-market rally." But the optimists point out that, in both 1974 and 1982, when stocks staged strong rallies from low points, those gains also began with sharp surges that looked a lot like bear-market rallies.
So far, the industrial average hasn't broken back through the high of 8931.68 it hit on Nov. 27. But the S&P 500 and the Nasdaq have broken to their highest levels in months, as have many individual stocks such as International Business Machines.
"We can have a bull market, but we aren't going to have a secular boom," says Mr. Herrmann of Waddell & Reed. He said he believes the current bull market will be of the cyclical variety, although he thinks it could be a long one. "It could last for several years, but not a decade," he says.
What worries many investors is that the current economic and financial climate still has some nasty flaws. Savings rates remain low, corporate balance sheets aren't as solid as they should be and debt levels remain high both at companies and among individuals.
The housing boom that has sustained the economy seems to be topping out, and business investment, which was supposed to take its place, isn't picking up. With factories operating at their lowest rates in 20 years and with huge amounts of unused production capacity remaining, businesses see little need to spend huge amounts on new equipment. And businesses still aren't hiring.
Stock prices are high compared even with expected future earnings, leaving relatively little room for more sharp gains.
So the analysts at places such as Ned Davis Research, Bridgewater Associates and Waddell & Reed are optimistic, but only guardedly so. Plenty of opportunity remains for this rally to fail. But the longer the rally lasts, and the more indexes and stocks break through recent highs, the more investors will jump in and start buying stocks again, and the greater the chances will be that the rally can turn into a longer-running one.
Even some committed bears are starting to sound like at least short-term bulls. "While we still believe we are in the midst of a bear market, we don't dismiss this rally as lightly as we did the four previous moves since the market's March 2000 peak," wrote bearish money manager Brett Gallagher of Julius Baer Investment Management in a report to colleagues last week. He said he may be forced to buy more stocks. |
