- NEW YORK (Reuters) - Who
says Wall Street isn't the greatest stock-pricing machine?
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- After driving stocks higher late last year on hopes the
economy would bounce back from recession, investors sensed by this summer
that something was awfully wrong. They pulled $50 billion from U.S. stock
mutual funds, a record withdrawal that sent the market into a horrific
drop.
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- What happened is the average investor dismissed upbeat
stories from analysts and ignored Washington's claim of a disconnect between
stocks and the economy.
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- Indeed, small investors were correct in not accepting
a turnaround in the economy. Six months into 2002, economic growth has
nearly stalled with second-quarter growth increasing at a measly pace of
1.1 percent after racking up a huge 5 percent gain in the first quarter.
Clearly, the economic recovery was slower than most experts thought.
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- "While many analysts believe that the market is
out of sync with the economy, it is much more probable the widespread forecast
of economic recovery is out of sync with the market," says John Hussman,
professor of economics at the University of Michigan and publisher of Hussman
Econometrics, a research report.
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- LISTEN TO THE MARKET
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- "Given an economic recovery, the argument goes,
the stock market should be performing much better," he says. "Unfortunately,
when market action disagrees with the optimism of analysts, central bankers
and presidents, it is the market that has the better record of looking
ahead."
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- Smart investors are now sitting on the sidelines after
pulling $52.6 billion from stock mutual funds in July, the largest monthly
outflow in history, topping $30 billion in September 2001.
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- "The pain and the fear became unbearable and several
million investors gave up at virtually the same time," says Don Cassidy,
senior research analyst for Lipper Inc., a fund tracking firm.
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- The remarkable thing was investors finally took control
of their investments in July and they turned the table around on their
brokers who kept telling them to "buy, buy and then buy some more
stocks."
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- People are now waiting for the economy and corporate
earnings to improve before jumping back into the market. They refuse to
be sucked into believing Wall Street cheerleaders who say that a half dozen
consecutive quarters of lousy corporate results were simply a speed bump.
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- Stocks are hovering near 5-year lows, which says the
market does not expect any improvement in earnings for another six to nine
months.
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- The Dow Jones industrial average is down about 13 percent
for the year, Standard & Poor's 500 has tumbled 20 percent and the
Nasdaq composite has crashed 32 percent.
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- The betting is stocks may stay in the dog house at least
through the end of the year because corporate profits will not be strong
enough to pull the market higher.
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- Despite the headlong dive by technology stocks, the froth
still has not been fully squeezed out of the bubble of the 1990s. The sector
remains pricey, trading 25 times next year's earnings.
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- The overinvestment boom of the '90s produced so much
capacity that it will take longer to work off the excesses than in a traditional,
garden-variety inventory correction. Also, the recession that started in
March 2001 -- one year after the market went into a bone-jarring plunge
-- was too brief to have worked out the excesses.
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- Hussman says the bullish analysts are having a hard time
understanding the market is conveying information that's observable and
measurable.
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- "If an analyst respects market action and examines
it carefully, the market willingly offers up a great deal of information
-- long before it shows up in widely followed economic statistics or earnings
reports," he says.
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- In Hussman's estimation, the risk of being in the market
right now remains unusually high, even after its awesome slump during the
last 2-1/2 years.
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- "This is not a bet or a forecast the market will
decline," he says. "Rather it is an attempt to avoid sources
of risk that are not associated with a strong expectation of (stock) returns."
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- SURPRISE, SURPRISE
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- Despite having constantly misjudged corporate America's
profitability for more than a year, analysts who "need" to be
bullish still haven't removed their rose-colored glasses. They're running
with the bullish herd, projecting a tremendous recovery in the second half.
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- The cold reality is that the "brightest" analysts
have historically been absurdly optimistic about projecting corporate earnings
months to one year forward because they're too close to the industries
they cover.
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- Veteran traders say the best rule of thumb in getting
the true earnings picture is to lop off at least 1 percent per month on
the analysts' estimates.
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- While corporate earnings in the just-completed second
quarter inched up 1.1 percent compared to a year ago, analysts believe
third-quarter earnings will jump 11.4 percent and then leap by an eye-popping
23 percent in the fourth quarter.
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- Strange as it may seem, they are forgetting the cardinal
rule of forecasting: economic growth drives corporate earnings.
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- The other reality is that the National Bureau of Economic
Research, the official arbiter of recession dating, is still questioning
whether the economy has yet hit bottom.
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- The other truth is that in five of the last six recoveries
from recession, the economy has fallen back into negative growth.
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- NOT YOUR RUN-OF-THE-MILL RECOVERY
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- In past recessions, the economy was able to bounce back
smartly because there was a build-up of demand waiting to be unleashed.
But 2001 brought something unusual, a business-led recession as companies
stopped spending.
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- This week, Intel Corp. INTC.O said it expects only modest
growth in third-quarter earnings because businesses are still not spending.
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- During the brief recession, which supposedly ended early
this year, the economic hard times were minimized by steady spending by
consumers who kept buying homes and cars, thanks to the lowest interest
rates in decades. Consumers and housing have traditionally been the major
sources of strength in a recovery.
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- But the trouble is that consumers have now mortgaged
themselves to their eyeballs, even after losing $7.8 trillion in stock-market
wealth. In the rush to refinance mortgages, people are cashing out on the
fast-rising values of their homes, sucking out the pent-up equity so as
to keep spending on stuff.
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- The big question is: with so many people tapped out financially,
will they take their game ball and go home or continue single-handedly
to keep the economy afloat?
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- As for business spending, there are few signs it will
pick up any time soon because companies are not confident about their own
future. And they're also unsure that consumers can get a second breath
at this stage of the economic cycle.
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- For the week, the Dow fell 2.4 percent to 8,663, the
Nasdaq lost 4.75 percent to 1,315 and the S&P 500 dropped 2.6 percent
to 916.
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