Schism On Wall Street

It seems as if there are two markets lately: Tech--and then everyone else

It seems like only yesterday that the stock market was all smiles. As recently as Jan. 14, the Dow Jones industrial average set a record. Since then, though, there has been plenty of bad news. Fears of inflation have pushed up interest rates. The Dow industrials have fallen 13%. Stocks in just a handful of sectors have risen so far in 2000. Only the Nasdaq Composite Index, which hit a new high on Feb. 23, has escaped. Worst of all, Federal Reserve Board Chairman Alan Greenspan seems to want to put a lid on stock prices.

It's enough to bring tears to the eyes of a bullish investor. Things were bad enough already, but "Greenspan greased the slide," says Albert Goldman, chief market strategist for brokerage A.G. Edwards Inc.

It's a correction, certainly--but is it more than that? Stocks began sliding long before Greenspan went to Capitol Hill to face a grilling from Congress. And the performance of widely watched market indexes doesn't begin to tell the story of what almost looks like a stealth bear market in all but technology. Last year, for instance, the Standard & Poor's 500-stock index rose 21%--but just 20 stocks accounted for 93% of the rise, says Laszlo Birinyi Jr., global strategist for Deutsche Bank Securities Inc.

Most S&P sectors are down substantially since last June 30, when the Fed began raising interest rates, according to Standard & Poor's Corp. Go down the list: Consumer stocks are down 20% through Feb. 18. Financial-services companies, from banks to insurers, are in the tank. Energy companies are weak even though First Call Corp.'s survey says earnings should rise 43% this year. Drugmakers can't win investor interest.

Indeed, as stock market troubles spread, the gap between the fortunate few and the rest of the market is widening. The Old Economy market is limping along, while a smaller New Economy market seems largely impervious to higher interest rates, fears of a slowing economy--or just about anything else.

The separation of fortunes was clear on Feb. 23, when Greenspan defended his controversial new strategy for reining in the economy during his annual Humphrey-Hawkins testimony to Congress. The Dow Jones industrial average fell 79 points on the day, to 10,225. But the technology-heavy Nasdaq soared 3.8%, to a record 4,550. Amazingly, the Nasdaq has tripled since October, 1998, thanks to stars such as Cisco Systems Inc. and Qualcomm Inc. Also up on Feb. 23 was the small-cap Russell 2000, which has risen 32% since October thanks to technology and biotech stocks.

The bottom line: If you're not heavily invested in tech these days, you're out of luck. The biggest gainers lately are companies such as JDS Uniphase Corp., a maker of fiber-optic gear whose stock is up 46% this year. But in a jittery market, the increased selectivity that is swamping many a nontech stock is playing out even in that charmed sector: Many of the bigger, more traditional tech players are getting hit along with the broader market. IBM is trading around 109, down from 135 last December. Microsoft Corp., under the shadow of antitrust litigation, is at 94, down from 119. Dell Computer Corp. is selling for 41, down from a high of 52.

Why is the stock market turning glum even though the longest-lived economic expansion in U.S. history continues to boom along? One explanation is a spreading fear that the good times can't possibly last--that corporate profits are bound to be whacked by higher inflation, higher interest rates, or both. "Investors are responding in a Pavlovian way to the idea that higher rates are going to soften earnings for the rest of the year," says one bull, Ned Riley, chief investment adviser at State Street Street Investment Advisors in Boston.

But that can't be the whole story, because most analysts aren't lowering forecasts for corporate profits. According to a First Call survey, consensus analyst estimates for profit growth in 2000 have remained steady at 17% since the end of November.

Perhaps the bigger factor, then, is psychological. For years now, investors have piled into stocks because they figured they had nowhere to go but up. It was a momentum play, and it has paid off handsomely--nowhere more so than in Net-related stocks, where incredibly outsized gains were fueled by equal degrees of investor hope and hype. But lately, investors are no longer so confident about buying on the dips--or waiting for an elusive payoff in the absence of earnings. "They're becoming a lot more selective," Riley says.

At the same time, there's still a lot of money out there looking for the next Microsoft or Dell. And with prospects dimming in much of the market, these momentum investors are crowding into an ever-smaller handful of industry groups that are still capable of producing the sort of breakthrough that causes earnings--and stock prices--to soar. Today, that short list includes genetics companies, semiconductors, and business-to-business Internet stocks.

Meanwhile, even the best among big, established companies with stable earnings growth are being sold off. General Electric Co., for example, had 14% profit growth last year and is expected to do the same this year. Still, its stock is 19% off its December high. Shares of Wal-Mart Stores Inc. have plummeted 30% in the same stretch because investors are worried that it won't be able to match last year's 20% earnings growth. And forget an expected 57% jump in earnings this year for Alcoa: Its stock has dropped 17% from its January high. "Circle the wagons," counsels Birinyi. "Good stocks are going down. Expensive stocks are getting more expensive."

That disparity has people who make a living selling stocks frustrated that Greenspan seems to be kicking the stock market when it's down. They argue that he's paying too much attention to highfliers such as Cisco and Qualcomm. "Higher rates won't hurt the virtual economy, but they sure will hurt everyone else," argues Jeffrey Applegate, chief market strategist for Lehman Brothers Inc. Applegate compares Greenspan's attempt to control the prices of stocks with the wage-and-price controls imposed in the 1970s by President Nixon.

The idea that technology is invulnerable to higher interest rates may not always hold, but it's widely held--and on Wall Street, perception is reality. So far, there's little evidence that the boost in rates is hurting most tech stocks. One reason may be that high-tech profits are expected to grow 29% this year. And tech companies' revenues are perceived to be less sensitive to interest rates than Old Economy companies'. For example, higher rates could hurt sales at General Motors Corp. more than EMC Corp., the nation's top computer-storage company, because "people can hold off on buying cars, but companies have to invest in technology," says Thomas M. McManus, an equity strategist at Bank of America. Moreover, the strong cash flows that many technology companies generate makes them less dependent on borrowing to finance expansion plans or other spending needs.

Still, the stock market might be doing even worse if investors were fully convinced that Greenspan really will aim to limit the stock market's rise to the rate of income growth, as he has signaled. But some analysts think Greenspan is partly bluffing. "The folks at the Fed are too smart to do something so politically risky, economically senseless, and intellectually flawed," argues Applegate. Correctly or not, many analysts say they doubt Greenspan will jack up rates severely if inflation stays in check.

Of course, Greenspan isn't the only wet blanket on the stock market. Some of the pressure is from "bond market vigilantes"--bond investors who drive up rates when inflation threatens. The yield on 10-year Treasury notes has risen fully 2 percentage points from its low in October, 1998, to 6.4%. Higher rates hurt profits by raising borrowing costs and choking off consumer demand. Also, higher yields on bonds make them a more attractive alternative to stocks for investors.

All in all, not a pretty picture. If the Fed is the new bete noir, what's ailing the stock market is far more than just Alan Greenspan. And though sentiment could take a sudden turn for the better, for now, investors are just hoping the Dow industrials can hang in above 10,000.

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