The Street's Fear: `The Crazy Things Congress Might Do'Jeffrey M. Laderman
For most of 1991, the stock market has racked up mighty snappy gains, based on several key assumptions: falling interest rates, a recovery in the economy, and the 1992 reelection of George Bush. Only a month ago, the Dow Jones industrial average hit an all-time high of 3077 and, until recently, was poised to raise the ceiling anew. All of a sudden, those assumptions don't look quite as solid to Wall Street. The President's eroding support in public-opinion polls, his Hooveresque assertion that the economy's O. K., and a feistier Democratic Congress all are raising investor anxiety.
Wall Street hasn't abandoned the beliefs on which the current bull market is built. But the confidence in its assumptions has dropped. On Nov. 15, the Dow suddenly fell victim to one of those infrequent but frightening triple-digit drubbings, dropping 120 points in all, half of that in the last hour. The plunge raised the specter of the horrific sell-offs of October, 1987, and October, 1989. The Dow made a modest comeback the next trading day, Nov. 18, but lost it and then some on the 19th. By Nov. 20, the market had steadied a bit, with the Dow at 2930.
LOUD HOWLS. While many investors had been anticipating a pullback, the speed and severity of the correction were shocking. Many blamed Washington, and especially the U. S. Senate, which passed a bill that would cap interest rates on credit cards. Wall Streeters howled, and bank stocks collapsed -- taking the broad list of stocks down with them. Credit cards are one of the few businesses the ailing banks can count on for profits. They're sorely needed to rebuild bank capital. What's more, in Wall Street's view, the legislation was a purely political ploy that would not spur consumer spending -- and that might well hurt it, by cutting off credit to millions.
It's little consolation to know that the measure is probably dead. "That bill whipped through the Senate in one day," notes George W. Jacobsen Jr., chief investment officer of Trevor Stewart Burton & Jacobsen Inc. "You have to be concerned about what other crazy things the Congress might do."
Wall Street has also railed at President Bush's seeming indifference to the market's fall. Investors don't necessarily want any additional government action, but they abhor a leadership vacuum. "Bush is woefully out of touch, and no one has faith that anyone in Washington knows what he's doing," says James F. Barksdale of Equity Investment Corp. in Atlanta.
Investors' greatest worry on the political front? That Bush's reelection may now be in peril. "People think of a Democratic Administration, and they remember the high inflation and high interest rates of the Carter years," says William LeFevre, market analyst for Tucker Anthony Inc. "What could they possibly do that's going to help the economy?" asks John Snyder, who runs the John Hancock Sovereign Investors Fund. A tax cut for middle-class taxpayers? "Given households' debt structure, they would probably use it to pay down debt, not for new spending." And an investment tax credit for corporations, he adds, would take another year to have any impact.
DOUBLE JOLT? Some investors fear that new spending programs could stimulate the economy at the same time that the Federal Reserve's aggressive easing of monetary policy, which has brought short-term interest rates to the lowest level in nearly two decades, starts to have an impact. "There's always a lag between cuts in interest rates and the time they help the economy," says Michael Schonberg, managing director of UBS Asset Management. Indeed, piling fiscal stimulus atop the monetary stimulus could reignite inflation -- and send interest rates higher.
In fact, some argue that no fiscal help is needed, because profit prospects are improving. While many investors look back to the disappointments in the third quarter's earnings reports, the picture ahead looks better. Over the past month, 32% of the revisions of analysts' 1992 earnings estimates were positive, vs. just 27% the month before, according to Zacks Investment Research. Even the fourth quarter doesn't look so bad. Analysts are now looking for a 13%-to-14% gain in profits over 1990. A month ago, they were predicting a gain of around 11%.
Although investors blame Washington for the latest round of woes, there was a strong case to be made for a correction on purely technical grounds. The 13-month-old bull market has yet to have the classic 10%-to-15% pullback that's part of Wall Street's ebb and flow. Even after the sell-off, the Dow had dropped only 4.8% from its high. For the year, the Dow is up 11.3% -- and up 23.9% from the 1990 bear-market bottom.
The broader indexes have been even stronger. The Standard & Poor's 500-stock index is up 14.6%, and up 28.1% from its cyclical trough. The NASDAQ Over-the-Counter Composite has climbed even higher -- up 40.7% in 1991 and up 61.7% since the 1990 bottom. Included in the OTC market are most of the biotechnology stocks. On average, they were up 130% for the year before the correction set in. So far, the biotechs have fallen just 7.7%.
For the coming several weeks, the market's short-term upside potential will be crimped by money managers who will sell into rallies to lock up some gains before yearend. But such selling does have a salutary effect. It allows investors to rebuild the cash reserves that have been drained by the buying spree and by the record number of initial public and secondary equity offerings.
Opportunistic money managers are making the most of the decline. Schonberg of UBS, who thinks the economy will grow at a peppy 4% rate next year, has been buying such cyclical stocks as Alcoa, Digital Equipment, and USX, which have been hit hard of late. Trevor Stewart's Jacobsen, on the other hand, is bargain-hunting for food, tobacco, beverage, and consumer-products growth stocks. Warren Shaw, who oversees $6 billion in equity investments at Chancellor Capital Management Inc., says he will also buy growth stocks if the
market drops to the mid-2800s.
That should be the bottom of any correction -- the point from which the Dow has bounced back several times before. But that, too, is predicated on interest rates' staying low, or going even lower. Returns on U. S. Treasury bills, money-market funds, and certificates of deposit are so low that the relatively paltry 3.1% yield on the S&P 500 doesn't look so bad. And next to longer-term investments such as 10-year U. S. Treasury bonds, the yield gap is the narrowest it has been in months (charts, page 33).
That bodes well for stocks. And given the forces already at work in the economy, many market-watchers think rates and inflation will remain friendly to equity investors. And, yes, they even think the economy will eventually come along -- unless Congress or the President steps in and tries to "help."