The big picture……..Part 2
Newsweek December 7, 1998
newsweek.com
Why the Big Bounce?
Wall Street gurus have plenty of explanations for market moves--after the fact. Herewith, seven pillars of conventional wisdom about the comeback.
By Allan Sloan
We stock owners had a lot to be thankful for on Thanksgiving. In October Wall Street was Gloom City. The bull market was over. The Dow Jones industrials and Standard & Poor's 500 Index were down 20 percent from their summer highs and seemed headed lower. Hedge funds, those unregulated investment pools that cater to rich investors, were going to collapse and bring down the world's financial system. That is, if Japan didn't bring it down first. And the market decline was a harbinger of a nasty recession in the United States. Wrist-cutting kits were going to be the next big growth industry.
But now it's the people who bailed out of stocks who were the turkeys. Those of us who hung in when things seemed hopeless are gobbling up profits. The gloom is gone. Life is good. Recession? What recession? The Dow, which dipped as low as 7467 in intraday trading on Oct. 8, climbed 1,900 points--more than 25 percent--to a record 9374 on Monday before falling back a tad. The S&P, which traced a similar arc, ended the week at a record high.
It would be nice to find a logical reason for stock prices' climbing the first half of the year, crashing during the third quarter, then rising again. But not all market moves are logical. Markets tend to extremes--they get irrationally high, then irrationally low, then irrationally high. Think of it as financial bipolar disorder. To attribute wisdom to every twitch is madness. Sometimes market rises or falls predict what will happen in the real economy--and sometimes they don't.
In honor of the holidays, let's skip the usual experts and take the fowl turkey puns as given. Herewith, based on conventional wisdom and NEWSWEEK's own analysis, are Seven Reasons the Market Has Been Rising. Before you send me a nasty letter or e-mail, please note that in some cases, my tongue is firmly in my cheek.
Alan Greenspan is our guardian angel: Believe that, and you also believe that in less than a month, a fat man in a red suit will slide down your chimney and leave you presents. Yes, Greenspan, chairman of the Federal Reserve Board, has cut short-term rates three times in two months. These include a surprise Oct. 15 cut that came shortly before the close of trading on a "triple witching" day in which many options and futures expired. The Dow rose 200 points before you could blink, and has kept on going.
But don't think that Greenspan is looking out for us retail stock investors. The Fed never comments on its motivations, but I'll bet that Greenspan's goal was to restore confidence in the credit markets, not the stock market. Much of the bond market had ground to a halt in October because of the collapse of Long-Term Capital Management--the now infamous hedge fund that was kept afloat in a Fed-organized (but privately funded) $3.6 billion rescue.
Greenspan is said to be unhappy with stocks' recent rapid rise. It's easy to see why. If you believe that stock prices should have some relationship to corporate profits, you have trouble justifying today's valuations. Stocks are rising while earnings are falling. The Asian contagion has finally reached the United States, cutting profits of U.S. companies in Asian markets and increasing competition here from Asian companies. Yet even though profits are falling, the S&P 500 is at a record high 27 times the past 12 months' profits, according to First Call.
Anyone counting on Greenspan to protect us little investors is in for a nasty shock. Just remember how he cut short-term interest rates sharply in 1990 to bail out Citibank and other zombie banks that were awash in bad loans, but were considered too big too fail. That drove yield-hungry investors, such as retirees, into long-term Treasury bonds and "emerging market" debt. After the banks got well, Greenspan raised rates, Treasuries tanked and "emerging" markets submerged yet again. The little guy got killed.
So put not your faith in Greenspan. Among other things, Greenspan must worry about the "moral hazard" created by bailing out the U.S. stock market, however inadvertently. "Moral hazards" arise when people who buy risky things like Thai government bonds get bailed out by international rescue missions designed to keep countries afloat. Goosing the stock market, as the rate cuts have done, is the "moral hazard" to end all "moral hazards." It's such a dangerous precedent I can't believe Greenspan will dare do it again.
Corporate takeovers: The animal spirits are roiling the market again: Deutsche Bank is bidding to buy Bankers Trust, AOL is buying Netscape and on and on. A record half-a-dozen billion-dollar-plus takeovers were announced or leaked on Monday, helping send stocks to record levels. Takeovers raise prices, if only because investors bid up the companies they think may be next to be bought. But you have to wonder about the wisdom of the buyers. September or October would have been a better time to buy, because stocks were generally lower then. Anyway, many of the deals involve trading the buyer's overpriced stock for the seller's overpriced stock. It's like trading a $50,000 mongrel dog for two $25,000 alley cats.
Japan is straightened out: Well, maybe. But we've heard this before, and it hasn't happened yet. Despite a recent rally, Japanese stocks are still down 60 percent from their 1989 highs, and the banking system is so far underwater that it might as well be a submarine. Japan is forever announcing "reforms," but nothing much seems to change. I'll believe Japan is fixed when I see it. Which may be a long time from now.
Baby boomers have to buy stocks to fund their retirement: There's something to be said for this. But what about August and September? Boomers managed to find something else to do with their money. Some of them--horrors!--actually sold stocks. The idea that stocks have to go up because people have to buy them scares me even more than Internet stocks' going up 30 or 40 or 50 percent a day for no apparent reason. It's the old momentum story. Money floods in when stocks are rising, and floods out when, for whatever reason, they start to fall. Buying stocks because you think other people are also buying is what's known as the Greater Fool Theory.
Everything is faster these days; we had an eight-week bear market: Instant communications, the Internet and the increase in TV, radio and print coverage of stocks do make things move faster than they used to. Some people--not including me--define a bear market as a drop of 20 percent or more from the market high, a decline reached on Oct. 8. Forgive my being picky, but a bear market is not only numbers, but state of mind. It's when stocks go down and stay down so long you wonder if they will rise again. This wasn't a bear market. It was more like a bear burp.
What's more, numbers assembled by Jeffrey Warantz, an equity strategist at Salomon Smith Barney, make a case that many stocks are in their own bear market. As of Nov. 24, Warantz says, 59 percent of New York Stock Exchange issues, 79 percent of Nasdaq issues and more than 200 of the S&P 500 stocks were down at least 20 percent from their 52-week highs. The average S&P 500 stock is up only about 4 percent even though the S&P is up more than 20 percent. Reason: the index is being skewed by a small number of heavily weighted stocks like Microsoft, Wal-Mart, Lucent and Cisco, which are up 100 percent or more.
The market generally rises on Thanksgiving week: This argument and its corollary--December and January are good times to invest because of inflows from pension funds and mutual funds--is like arguing that October is a bad month because crashes tend to happen then. In fact, the Dow dropped 210 points on Oct. 1, sending October Surprise types into ecstasy. But then it rose 960 points, finishing up 750 for the month.
Arguing by historical analogy is like saying the S&P 500 wouldn't return 20 percent (in price rises and reinvested dividends) in 1997 because it had done so in 1995 and 1996, and had never done so three years in a row. The S&P returned 33 percent last year.
Then there's my favorite: the market has a bad year when an old American Football League team wins the Super Bowl. The Denver Broncos, a former AFL team, won last year. The broad market doesn't seem to have crashed, does it?
Time and NEWSWEEK had gloom-and-doom covers: Time's Sept. 14 cover was "Is the Boom Over?" Showing even better timing, my employer NEWSWEEK had an Oct. 12 cover called "The Crash of '99?"
What more can I say?
With Rich Thomas
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