From Investor Business Daily, May 12,1998
NATIONAL ISSUE
THE MARKET HAS TO TOP, RIGHT? Sometimes
Market Watchers Worry For Wrong Reasons
Date: 5/12/98
Author: Loren Fleckenstein
With each leg up, the great bull market sets off a fresh fit of nerves and another search to find
some
reason - any reason - to declare the end at hand.
Worriers can take some comfort from the past. Rich stock prices, the source of much of the
current
hand-wringing, don't kill bull markets. High stock valuations, financial pros say, are nearly
useless in
timing market turns.
History shows it takes a powerful outside shock to bring on a bear market. In the post-World War
II era, the U.S. has had 17 bull markets. That includes the current one, which is the longest bull
market ever and continues to show strength after a 7 1/2-year run.
''Great bull markets don't end just because they're overvalued,'' said Anthony O'Bryan, market
analyst for A.G. Edwards Inc. ''There's always got to be a trigger. Sometimes, it's an
unforeseeable
event, like war. Usually, it's rising interest rates.''
The bull market ends in fear, according to Jeff Hirsch, who publishes Stock Trader's Almanac
with
his father, Yale Hirsch. And that fear must spring from deeper roots than high valuations or
slowing
earnings.
''Something outside the market scares people about the future of their investments,'' Jeff Hirsch
said.
''Liquidity drives the market now. It will take something outside the markets -something political,
something economic, something international - to change that liquidity. It takes scissors to cut
the
tape.''
The 16 prior postwar bull markets, according to economists and Wall Street pros, were ended by
decisive economic and political events.
Six postwar bull markets fell prey, in the main or in part, to interest-rate hikes by the Federal
Reserve. They include the second-longest bull market, which ran from June 13, 1949, to May 6,
1956.
One Fed-driven market top came on April 27, 1981. The Fed had raised rates three times in '80,
and a final hike on May 8, 1981, pushed the discount rate to a record 14%.
In 1987, newly appointed Federal Reserve Chairman Alan Greenspan tightened rates. That
helped
set off a plunge of 508 points, or 22.6%, on the Dow on Oct. 19 that year.
War brought on two bear markets, including the last bear market. It started on July 16, 1990,
when
Iraq invaded Kuwait. The Vietnam War and social turmoil had conspired to bring about a bear
market that began on Dec. 8, 1968.
The oil embargo imposed by the Organization of Petroleum Exporting Countries was the chief
culprit
in the vicious bear market that began on Jan. 11, 1973, and lasted into 1974. Another OPEC
price
hike is blamed for the Sept. 9, 1978, top.
Presidential politics have played a role in several market tops. John Kennedy forced the steel
industry to rescind a price hike in '62, at a time when the SEC was investigating a wide variety of
alleged stock market abuses, including insider trading, unregistered stock sales, falsified
prospectuses and margin violations. Those factors helped end a bull market that topped on the
final
day of 1961.
Richard Nixon took the dollar off the gold standard Aug. 15, 1971. The bull market had topped
just
a few months before.
In fall '97, many were wondering whether a bear market was at hand. Stocks entered a severe
sell-off in October and struggled through a two-month correction.
Then in '98, the bull charged back to life. The Standard & Poor's 500, the Dow Jones industrial
average and the Nasdaq Composite indexes rolled ahead to new high ground.
The run-up came as earnings growth fell sharply among large-cap companies. With 90% of S&P
500 companies reporting, year-over-year earnings-per-share growth is running at 4% for the first
quarter of '98 compared with a 16% rate in the first quarter of '97.
Bears point to a widening gap between earnings and share prices. In a recent cover story,
''America
Bubbles Over,'' the influential British newsmagazine The Economist argued U.S. equities have
formed a dangerous bubble and are primed to deflate.
One person who sees a bear market brewing is Don Hays, chief investment strategist at Wheat
First
Union Inc. He points out that the Dow gained 15% in the first quarter, while earnings
expectations
for the S&P 500 plunged from 10% growth to nearly flat for the same period.
For an outside cause to kill the bull, Hays points to Asia.
''The dominoes haven't fallen yet, but we think there are hints already,'' Hays said. ''It's very
obvious
that Japan's having massive problems. China let out the first little hint that a devaluation is a
possibility. We think Tuesday's meeting (May 5) between Greenspan and Clinton was very
significant. We think Asia has them scared out of their shadow.''
Stock market historian Yale Hirsch notes that there have been extended periods of disconnects
between the performance of earnings and share prices.
From the end of 1950 to the end of 1959, for example, the Dow Jones industrial average rose
189% to 679. But over the same period, Hirsch notes, earnings ''slept.''
Annual earnings for the Dow's component stocks stood at $30.70 at the end of '50. Over the next
nine years, earnings wavered between a low of $24.78 and a high of $36.08.
The Dow index also left earnings in the dust in 12 years from '75 to '86, tripling in value while
earnings seesawed.
Some market watchers have suggested the retirement-savings boom is immune to the cycles of
fear
and exuberance that have swept the stock market in the past.
The Investment Company Institute, the mutual fund industry's trade group, estimates that in
1990, at
the end of the last bear market, 23 million Americans, or 25% of households, owned fund shares.
That has grown to 66 million Americans, or 37% of households, that now invest in mutual funds.
Many do so through automatic deduction programs.
Vincent Warther, visiting assistant professor of finance at the University of Chicago Graduate
School
of Business, warns, though, that nothing guarantees investors' loyalty to equities.
''Baby boomers saving for retirement - that's a big reason for this money flowing in. That's going
to
be true for a long time to come,'' Warther said.
''But those investors still have the choice of where to put that money,'' he added. ''If something
happens to investor psychology or optimism, they would still be saving money. But they could
switch
it grossly to bond funds.''
That occurred during the '87 crash, Warther notes. An equivalent free fall in stocks today, he
calculates, would cause more than $80 billion in mutual fund assets to shift from stocks to bonds
over three days.
The most common cause of bear markets remains Fed rate hikes. Clearly, tighter credit is
foremost
on the stock market's mind today, with Asia running a close second.
Gross domestic product grew at a brisk annual rate of 4.2% in the first quarter, with April
unemployment at 4.3% of the civilian work force, a 28-year low. That combination of tight labor
markets and strong growth has fueled fears that the Fed will have to tighten to head off runaway
inflation.
But consumer prices have barely budged on the national level. And there is deflation in
wholesale
prices.
The Bureau of Labor Statistics recently reported the employment cost index, which measures
wages
and benefits, rose a weak 0.7% in the first quarter of this year, down from a 1% gain in 1997's
fourth quarter.
O'Bryan of A.G. Edwards contends that the stock market could absorb some tightening.
''It takes more than one or two raises by the Fed to cause a bear market,'' O'Bryan said. ''The
increases in the fed funds rate have to be accompanied by a feeling that a long string of
increases is
in the making.''
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Date: 5/12/98
The acting chairman of the Federal Deposit Insurance Corp., Andrew C. Hove, pointed to a
report
on banks' lending standards, saying they're making risky loans of all types. The new FDIC
survey
showed 21% of the banks making business loans frequently OK'd them for borrowers who lacked
the documented financial strength to support such loans.
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