The Markets' Uncertain Future
By Amey Stone
Plenty of investors breathed a sign of relief on Monday, Sept. 10 when the stock market stabilized following the previous Friday's frightening drop. On Sept. 7 a report that unemployment had risen much faster than expected in August spooked investors, sparking a 235-point slide in the Dow Jones industrial average and a 21-point drop in the S&P 500, bringing it to its lowest level in nearly three years. Over the weekend, hopes were building that a so called "capitulation" had taken place -- that everyone who was thinking about selling had already done so -- and that the bottom had been reached.
That would be nice, wouldn't it? But the truth is, as much as the market has tumbled already, there's no reason to think it couldn't fall further. For most of the summer, investors were content to sit tight, happy that the economic underpinnings of the stock market didn't seem to be getting any weaker. But given last week's drop, it's pretty clear that investors need to see some good news on the economic or corporate-earnings front -- and they need to see it fast.
"Until the profit picture begins to clear and actual [earnings per share]-estimate changes start to become less negative again, the market is in jeopardy of continuing its slide," wrote Brian Belski, fundamental market strategist with U.S. Bancorp Piper Jaffray in a Sept. 10 note to clients.
As the major market averages approach their April lows, the technical analysts, those who look at chart patterns, are raising the most alarm. They point to psychological barriers, like the Dow slipping below 10,000, and worry that selling could accelerate if the indexes slip below earlier support levels.
In his Sept. 10 bulletin, Jim Stanton, editor of Low Risk Strategy, "puts the odds at better than 50-50 that these markets can drop another 15% to 20% from current levels" in the intermediate term. He also notes that "there is still the possibility of a panic sell-off from current levels."
Paul Shread, a market analyst at Internet.com, believes the market will bounce near-term. Yet he thinks the chance of a crash is "higher than normal." For these folks, the big question is: What will happen if the Nasdaq, which closed at 1695 on Sept. 10, falls below its April low of 1638?
BEWARE OF OPTIMISTS.
Market watchers who look at investor sentiment are also raising red flags. For them, optimism on the part of investors is bad, since it means plenty of people still have stocks to sell. Analysts at Schaeffer's Investment Research note with alarm that the most common options strategy -- selling calls -- is a sign that investors see little risk the market could fall further. That firm thinks the Nasdaq could fall to the 1300-1350 level.
"We still have a somewhat optimistic individual investor," says Paul Hauck, co-CEO of WhisperNumber.com, a Web site that collects independent investors' estimates on corporate earnings. "That may not bode well for the market in the short term. That's a sign there is still some frothiness out there," he says.
Many, if not most, of Wall Street's top market strategists and economists are skeptical of technical analysis and indicators based on market sentiment. "Why not go to the root cause of market direction, which is the economy?" says Peter Coolidge, head of equity trading at Brean Murray & Co.
You'll find little cause for optimism there, too. "The biggest fear is that another shoe will drop in the economy," says Arthur Hogan, chief market analyst at Jefferies & Co. "If it does get worse and we see significant instances of either higher unemployment or lower consumer confidence, that would cause the major averages to correct to a lower level."
The surprisingly high unemployment number sparked selling because investors worry that fear of losing their jobs will finally cause consumers to rein in spending. Given the severe cutbacks in spending by corporations, strength in consumer spending has been keeping the U.S. out of recession. Many investors will have their eyes glued to the latest retail sales figure, due out on Sept. 14, for the next clue as to whether the consumer is cracking, says Jay Mueller, economist and portfolio manager at Strong Capital Management.
Weakness in the economy, of course, translates into sliding corporate profits. Even though stocks have dropped precipitously in the past year, earnings have fallen faster. That leaves many stocks still overpriced, points out Lord, Abett & Co. market strategist and senior economist Milton Ezrati. He believes many investors are still reluctant to sell the former New Economy darlings, propping up their stock prices. "We haven't yet gone through the necessary wave of selling pressure that would bring them into line," he says.
On the bright side, he thinks the broader market averages are more reasonably priced than they seem. He notes that while the price-earnings ratio of the S&P 500 is 23, if you take out some of the former tech high-flyers, it's only 18. And most of the fundamental analysts don't think there's a chance of a real market crash yet to come. "It's a little late for that," says Hogan. "The panic button has been pushed already." For Mueller, whether further downdrafts come in one day or in waves of ongoing selling is really "beside the point."
But Coolidge, who agrees that the market has already factored in much of the bad news that's out there, has a caveat: A real crash would require some kind of unanticipated shock to the market or the economy. For that reason, the weakening international climate, especially Japan's negative economic growth, bears watching.
For now, investors would do well to stay on the sidelines until signs of improvement appear. As low as the markets are, the averages could well fall further if the positive news investors have been expecting fails to materialize. The recovery will get here eventually -- and economists like Ezrati and Mueller still think it'll start showing up later this year. But when it comes to committing more money to a rocky market, you have no reason not to wait to make sure.
Stone is an associate editor of BusinessWeek Online and covers the markets in our daily Street Wise column.
Questions or comments? Join in the discussion at our Ask Amey Stone interactive forum
Edited by Douglas Harbrecht
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