A Turnaround Won't Surprise Abby Cohen
By Gene Marcial
Abby Joseph Cohen, chief market strategist at Goldman Sachs, has maintained her cool through it all. And it looks like her unwavering confidence in a market rebound is now being validated. The erudite and amazingly prescient market guru has been one of the few consistent -- and persistent -- believers in the stock market.
Never did she panic during the market's broad two-and-half-year decline. Even when things appeared to be darkest, Cohen exuded reasonable calm, patiently citing rational explanations behind the market's bearish gyrations.
On Monday, July 29, the Dow Jones industrial average rocketed more than 447 points, to 8711.88 -- capping a four-day rally. That was the second-largest percentage gain since the days after the 1987 market collapse. The biggest percentage gain, significantly, occurred on Wednesday, July 24, when the Dow jumped 489 points, or 6.4%. Over the past four days, the Dow zoomed up 1009.54 points, or 13%.
NO GLOOM AND DOOM.
In morning trading on July 30, the Dow had retreated from its July 29 highs and was down around 150 points before easing somewhat in the early afternoon. With the downside momentum apparently abating -- and maybe even switching to the upside -- some pros now think the market has hit bottom.
Cohen was ahead of the crowd. In a missive to clients on July 22, when so many other professional and individual investors were voicing doom and gloom, Cohen wrote: "Equities are priced too cheaply." Most investors were bailing out and dumping most, if not all, of their stock holdings, as the Dow plummeted that day by 235 points. It closed at 7784, way below its level of 10,600 in mid-March. The Standard & Poor's 500-stock index tumbled 28 points, to 819. The tech-heavy Nasdaq nosedived 36 points, to 1282.
To Cohen, however, it was clear that the bargain days were back -- and beckoning: "In early 2000, the pendulum swung too far in the direction of risk-tolerance. Today, we believe it has swung too far in the direction of risk-aversion," she argued in her note to clients. The risk premium that's now being implied in the falling stock prices is the highest in several years, she said. "Risk-aversion has become too intense."
A "BEAR TRAP"?
The stock market's spectacular rebound since July 22 hasn't turned many of the skeptics around. They argue that the rally is just that -- a short-term upswing that looks like a "bear trap," meaning it would suck in the optimists only to drown them in another massive decline.
The rally on July 29 "may have been too much, too fast," warns Mark Lebovit of VR Strategic Consultants, an adviser to institutional investors. He thinks the market is in a "short-term cyclical up period" that could last through mid-August to early September. But even Lebovit concedes that if the market fails to break under last Wednesday's (July 24) lows on the next pullback, this bull phase could continue for sometime.
For those who remain leery about the market's capacity to keep climbing, here's the reasoning behind Cohen's belief that equities are still priced too low: Investors' focus on liabilities has led to the current undervaluation, she argues. But what about the market's assets? They should be taken into account as well, she says. So, how do the assets stack up against the liabilities? Cohen thinks that's an important question, necessary to arrive at an accurate valuation of stocks.
The assets begin with the strong underlying structure of the U.S. economy, says Cohen. The U.S. has the world's most productive workers and a gross domestic product growth potential of about 3% annually. The economy, she argues, has already mounted a substantial recovery from the late '90s excesses in capital spending and inventories. On top of this, inflation has been modest, and interest rates are expected to stay low, she adds.
In the liability column is the collective concern about the veracity of company earnings reports. However, Cohen wrote, "we believe the accounting cleanup is well under way." The Aug. 14 deadline imposed by the Securities & Exchange Commission affects earnings reports that are now being released for the second quarter, she noted.
Other liabilities include: The dollar's decline; portfolio managers' use of momentum strategies that focus on short-term events, which fuel negativity and more selling; the potential impact of stock-price declines on spending decisions by companies and consumers; and the continuing confusion over how to value the market, which gets back to the quality-of-earnings issue and corporate accounting.
STRONGER THAN EXPECTED.
As proof that the shift to more conservative accounting has already begun, Cohen pointed out that in the past three quarters, companies in the S&P 500 announced write-offs and goodwill impairments totaling $165 billion. Plus, any economic damages the decline in stock prices have wrought "already have been incorporated in our economic and profit forecasts," wrote Cohen. Meanwhle, the dollar's decline -- "while not good for the national psyche, will likely boost economic and profit growth," she argued.
Earnings is one factor driving the market, says investment manager Louis Navallier of Navallier & Associates, which manages some $6 billion. The S&P 500 earnings for the second quarter have thus far exceeded analysts' estimates, he notes, "by gaining 1% instead of falling into the red for the sixth consecutive quarter." (See BW Online, 7/29/02, "The Earnings Recession? 'That's Over'".) "The bottom line," he says, "is that profits are stabilizing -- the best corporate news we've read in a long time."
What are investors to do now?
Cohen notes that in spite of the market's recent demonstration of resiliency, many portfolio managers are still waiting for a convincing upturn in stock prices before committing to equities. "This is the mirror image of 1999 and early 2000, when many investors were reluctant to reduce equity exposure while stock prices were rising," she said. She added that many investors who were anxious to buy shares when the Nasdaq stood at 5,000 are now concerned that the index is too expensive at 1300.
Such momentum-driven focus is due, in part, to the lack of confidence in fundamental forecasts. This has led investors to believe that a "premature reentry" into the stock market would be a poor business decision. That's especially true of investment pros whose clients have been disheartened by the market's dismal short-term performance.
But Cohen believes that investors with longer time horizons, such as managers of pension and endowment funds, may be among the first to reallocate assets -- if they haven't done so already -- toward stocks.
Marcial is BusinessWeek's Inside Wall Street columnist