The stock market doesn't seem like the layup it was a month ago. All the major indexes have fallen from their January highs (table). Investors are jittery. Some Wall Street wags are even starting to talk about a bear market. Others compose funeral orations for the technology sector and especially the Internet stocks.
Don't hang the black bunting yet. It's only a correction. Such pullbacks are just part and parcel of the stock market. Corrections perform a necessary function, squeezing out some of the excesses that build up in times of rapidly rising stock prices. In the fourth quarter of 1999, the Standard & Poor's 500-stock index was up 15%; the Nasdaq, an incredible 48%.
WHO WILL BUY? Of course, every bear market starts with a correction. So how do you know when a pullback in prices is just that and not the start of a bear market? Look at the nature of the decline in stock prices. If they are falling because a torrent of sellers is rushing for the exit, there may be trouble ahead. If, however, the decline is due to a dearth of buyers, it's more likely a correction than the start of a bear market.
Right now, it appears more like a shortage of buyers, says market watcher Laszlo Birinyi Jr. of Birinyi Associates. Take Jan. 28, for example, the day the Dow plunged 289 points, or 2.6%, but trading volume in the Dow stocks was the lightest since Jan. 13. Or look what happened to Dow stock J.P. Morgan & Co. It dropped more than 7 points, or 6%, even though Birinyi's analysis shows that there were, on balance, only 100,000 shares to sell. "That amount of selling should have knocked only a half a point to a point off the stock," says Birinyi. "But there were no buyers."
Poor business conditions can also turn a correction into a bear market, but that's hardly the case now. The U.S. economy, which grew at an estimated 5.8% rate in the fourth quarter, still has plenty of momentum. About 64% of fourth-quarter earnings have already been reported, and 65% of the S&P 500 companies have beat the analysts' forecasts, according to I/B/E/S Inc. "It's one of the best earnings reporting seasons in the past 13 years," says Joseph Abbott, senior strategist at I/B/E/S.
The wild card in all of this is the Federal Reserve. On Feb. 2, the central bank raised short-term interest rates one-quarter of a percentage point, a move the market had been anticipating for months. And the Fed's comments suggest that there's at least another quarter-point hike coming in March.
If those are the last hikes, the pressure is off equities, and stocks are likely to resume their ascent. Additional increases could put the market in a holding pattern for a while longer. But unless the Fed squeezes the economy so hard that the hoped-for soft landing turns into a recession, this bull market is not about to end.