The stock market on Feb. 23 replayed its November meltdown, dropping below last year's lows to a level not seen since April 1997.
But though stocks are now back at levels not seen since 1997, February's orderly slide feels very different from the sharp declines seen last fall. And that's what's worrying investors: November's crisis sometimes felt like irrational panic, driven by fears of a financial meltdown. February's sell-off, by contrast, seems driven by reality.
On Feb. 23, the broad Standard & Poor's 500-stock index closed at 742.33. That's almost exactly half the value of the stock market at the beginning of 2008. It's not just a recent bubble that has burst. If you bought into the overall stock market—represented by the S&P 500—at any point in the last 11 years, your shares are now worth less than you paid for them.
On Nov. 20, the S&P 500 closed at 752.44. But that return to 1997 levels came after the collapse of Lehman Brothers and amid genuine fears the entire world's financial system was near collapse. When investors calmed down and some rational optimism returned, investors jumped back in the market, bidding the S&P 500 up 24% by Jan. 6.
The Technicians Were Wrong
But since then, a series of developments has punctured many illusions that had driven the stock market's rally.
First, there was the technical analysts' argument that the November lows represented a floor below which the stock market would not fall. Technicians, who predict the market by studying market movements closely, repeatedly saw the market dip close to November lows but then recover. February's drop proves that the supports under that technical floor were very rickety.
Second, conditions in the economy and in the stock market are worse than ever than before. Many investors were betting on a recovery for the economy in the second half of 2009. However, so far there is nothing in the economic data to justify those hopes. "We've had three months of worsening data," says independent stock analyst Doug Peta. "Where we are now [in terms of the economy] is worse than the market was anticipating in November."
Disappointed in D.C.
Moreover, the expectations for earnings by companies are now far worse. Analysts are cutting earnings estimates on a daily basis, undermining a key measure that investors use to determine the value of stocks. Even with the market down 49% in the last 14 months, "I don't think stocks are necessarily cheap," Peta says.
But the biggest disappointment for investors has come from Washington and the banking system. While the Bush Administration's main focus was on stopping the market panic, investors hoped the new Obama Administration would find ways to end the credit crisis.
So far, investors haven't heard a coherent plan from Washington, says Quincy Krosby, chief investment strategist at the Hartford (HIG). "At this point, investors are just left waiting," she says. "The more you wait, the more you see deterioration of the overall economy."
Credit Markets Quandary
If any other sector of the stock market faced these problems, the rest of the market might be able to tread water. But the financial sector's troubles could turn into a deeper and more serious economic downturn. "As the financial sector goes, so goes the economy," Krosby says.
As chief economist at Ibbotson Associates, a subsidiary of Morningstar (MORN), Michele Gambera tracks a wide variety of economic data. But, he says, the key data point these days is the state of the bond market. He likens the credit market to the economic motor's transmission. "If the transmission is jammed, there is nothing that can move," he says.
Both investors and the Obama Administration are caught in a Catch-22. If policymakers like Treasury Secretary Timothy Geithner hurry and implement a plan quickly, it might not work. "The risk is that the current conditions force Geithner's hand to put together a hurried and less than comprehensive approach," warns Daniel Clifton of Strategas, a Washington consulting firm.
Waiting for Bold Moves
But as investors wait for a comprehensive solution, the economy and market conditions get worse. "There is no silver bullet," Peta says. "There isn't a nondisruptive way to fix everything."
Many investors fear a drastic step like the nationalization of banks, which would wipe out some shareholders. But others, like Peta, worry the Administration hasn't been bold enough.
For now, investors are stuck in an uncertain environment, where everything they scrutinize to make decisions — from earnings to economic measures to technical indicators — is deteriorating before their eyes. Stocks at these price levels could represent long-term bargains. But at a time like this, few investors are bold enough to challenge the bear.