Roulette Table: Correction or bear market?
Analysts try to divine stock market's slide
By BROOKE A. MASTERS
Washington Post
6/11/2006
NEW YORK - Now that the Dow Jones industrial average has shed 6.3 percent since May 10, it's time to ask the question: How do you distinguish a short-term stock market correction from a full-blown bear market?
You wait awhile, of course. But already there are clues in technical market data, such as who is doing the buying and selling, the price of stocks relative to corporate earnings, inflation data, and the length of time since the last recession.
Corrections, defined as a drop of 5 percent over a few weeks or a month or two, are pretty common. Since 1900, the Dow has fallen at least that much more than 300 times, or an average of more than three times a year, according to Ned Davis Research Inc.
But nine out of 10 such slides bottom out and start rising again. It's the other 10 percent that scare the pants off investors. They turn into bear markets, in which the broad market indicators lose 20 percent or more and take their own sweet time coming back.
Even the professionals have trouble telling the two apart.
In 2005, the Dow dropped more than 800 points - 8 percent - in March and April before rallying, then dropped an additional 400 points in September and October before climbing some more. In both cases, investors who jumped out prematurely would have suffered losses and missed another good rise.
On the other hand, analysts were full of rosy predictions in 2000 and 2001 that the market was simply resting briefly and would soon resume its dizzying climb. None of the major indicators have ever returned to their early 2000 highs.
"Picking the short-term movement of the stock market is like standing at the roulette table and saying, "I think red is coming up next' and then congratulating yourself when you are right," said Andrew Smithers, a British economic consultant. Though he published a book in March 2000 that correctly predicted that stocks were overvalued and about to tank, he called the timing "pure luck."
Now, consider today's investing environment.
Federal Reserve Chairman Ben S. Bernanke spooked the equity markets last week with comments that suggested the central bank is concerned about inflation and is likely to continue to raise interest rates. That prospect in turn raises fears that a significantly tighter money supply could push the already slowing economy into recession.
"There's some panic in the street," said Al Goldman, chief equity strategist for brokerage firm A.G. Edwards & Sons, "but I don't feel it's justified. . . . We don't have any signs that a recession is at hand, and inflation, although it's up, is still pretty well contained."
George Feiger, who runs Contango Capital Advisors, a wealth-management business, looks at the same signals and sees trouble. "All the technical indicators are showing that we must be getting near the end. The economy is slowing down, the dollar is tanking, people are pulling their money out of equities and putting them in cash, huge amounts of debt have been issued by below-grade (high-risk) issuers," he said. "Where else can it go? The real question is not where will it go but how far."
Interviews with nearly a dozen economists and market analysts turned up widely varying views on whether this particular market correction will develop fur and claws. That's partly because each one looks at different signals to determine where the equity markets are going:
Charles Biderman, chief executive of TrimTabs Investment Research, argues that the real answers lie in mutual fund flows and in whether companies are spending money to buy their own stock or that of other companies as part of a merger.
He noted that at the market peak in early 2000, individual investors were piling into equity funds but that companies were net sellers of stock. By contrast, at the bottom of the last bear market from June 2002 to February 2003, individuals pulled $100 billion out of equity funds, while companies were net buyers by $30 billion.
"Typically, individual investors are always wrong," Biderman said, "and ever since the mid-1990s, for every year when companies were net buyers of their own shares, the market has gone up."
Right now, Biderman notes, companies are again net buyers - he calculated that in May, 135 companies announced a total of $63 billion in stock buybacks and $40 billion more in stock purchases as part of takeovers. Meanwhile, individuals pulled money out of equity funds in May. His conclusion: "The economy is doing very well, and the market is underperforming."
James W. Paulsen, chief investment strategist for Wells Capital Management, also predicts good times ahead for stock buyers. He argues that corporate profits and consumer spending are still relatively strong and notes that even though the Federal Reserve has repeatedly raised the benchmark short-term interest rate over the past two years, the current level of 5 percent is still low by historical standards.
"I think the odds favor us getting over this and going back up to where we were," Paulsen said. "My bet is that we have not shut down the speed of world growth yet."
Some analysts are far less sanguine. Many of them rely on the relationship between a company's share price and its earnings to determine whether it is over- or undervalued, and they say that rapidly rising corporate earnings were the crucial engine behind the stock market's long rise from late 2002 through the first part of this year. S&P 500 companies are trading around 15 times operating earnings, well below where they were at the last market peak in 2000.
But some analysts are worried that high energy prices and the possibility - also mentioned by Bernanke last week - of a cooling economy could combine to make it harder for companies to post strong earnings growth.
"Earnings are going to be a little harder from now on," said Peter Jankovskis, director of research for OakBrook Investments LLC. Though he thinks the current drop is a correction rather than a bear market, he said small investors with extra money in their pockets might do well to put it in a money market fund or high-interest bank account until the current trend becomes clearer.
"The market definitely has cycles: Sell in May, stay away. Markets are generally weak in the summer," he said. "It won't hurt you to stay on the sidelines for a while."
On the other hand, investors who are already invested in equities shouldn't run for the exits, market watchers said.
"The worst thing that can happen is that people panic at the bottom, and it takes them a year or two to get over that panic. By that time, you've missed most of the next bull market," said Ken Tower, chief market strategist for CyberTrader, a Charles Schwab Co. subsidiary that focuses on active traders.
By BROOKE A. MASTERS
Washington Post
6/11/2006
NEW YORK - Now that the Dow Jones industrial average has shed 6.3 percent since May 10, it's time to ask the question: How do you distinguish a short-term stock market correction from a full-blown bear market?
You wait awhile, of course. But already there are clues in technical market data, such as who is doing the buying and selling, the price of stocks relative to corporate earnings, inflation data, and the length of time since the last recession.
Corrections, defined as a drop of 5 percent over a few weeks or a month or two, are pretty common. Since 1900, the Dow has fallen at least that much more than 300 times, or an average of more than three times a year, according to Ned Davis Research Inc.
But nine out of 10 such slides bottom out and start rising again. It's the other 10 percent that scare the pants off investors. They turn into bear markets, in which the broad market indicators lose 20 percent or more and take their own sweet time coming back.
Even the professionals have trouble telling the two apart.
In 2005, the Dow dropped more than 800 points - 8 percent - in March and April before rallying, then dropped an additional 400 points in September and October before climbing some more. In both cases, investors who jumped out prematurely would have suffered losses and missed another good rise.
On the other hand, analysts were full of rosy predictions in 2000 and 2001 that the market was simply resting briefly and would soon resume its dizzying climb. None of the major indicators have ever returned to their early 2000 highs.
"Picking the short-term movement of the stock market is like standing at the roulette table and saying, "I think red is coming up next' and then congratulating yourself when you are right," said Andrew Smithers, a British economic consultant. Though he published a book in March 2000 that correctly predicted that stocks were overvalued and about to tank, he called the timing "pure luck."
Now, consider today's investing environment.
Federal Reserve Chairman Ben S. Bernanke spooked the equity markets last week with comments that suggested the central bank is concerned about inflation and is likely to continue to raise interest rates. That prospect in turn raises fears that a significantly tighter money supply could push the already slowing economy into recession.
"There's some panic in the street," said Al Goldman, chief equity strategist for brokerage firm A.G. Edwards & Sons, "but I don't feel it's justified. . . . We don't have any signs that a recession is at hand, and inflation, although it's up, is still pretty well contained."
George Feiger, who runs Contango Capital Advisors, a wealth-management business, looks at the same signals and sees trouble. "All the technical indicators are showing that we must be getting near the end. The economy is slowing down, the dollar is tanking, people are pulling their money out of equities and putting them in cash, huge amounts of debt have been issued by below-grade (high-risk) issuers," he said. "Where else can it go? The real question is not where will it go but how far."
Interviews with nearly a dozen economists and market analysts turned up widely varying views on whether this particular market correction will develop fur and claws. That's partly because each one looks at different signals to determine where the equity markets are going:
Charles Biderman, chief executive of TrimTabs Investment Research, argues that the real answers lie in mutual fund flows and in whether companies are spending money to buy their own stock or that of other companies as part of a merger.
He noted that at the market peak in early 2000, individual investors were piling into equity funds but that companies were net sellers of stock. By contrast, at the bottom of the last bear market from June 2002 to February 2003, individuals pulled $100 billion out of equity funds, while companies were net buyers by $30 billion.
"Typically, individual investors are always wrong," Biderman said, "and ever since the mid-1990s, for every year when companies were net buyers of their own shares, the market has gone up."
Right now, Biderman notes, companies are again net buyers - he calculated that in May, 135 companies announced a total of $63 billion in stock buybacks and $40 billion more in stock purchases as part of takeovers. Meanwhile, individuals pulled money out of equity funds in May. His conclusion: "The economy is doing very well, and the market is underperforming."
James W. Paulsen, chief investment strategist for Wells Capital Management, also predicts good times ahead for stock buyers. He argues that corporate profits and consumer spending are still relatively strong and notes that even though the Federal Reserve has repeatedly raised the benchmark short-term interest rate over the past two years, the current level of 5 percent is still low by historical standards.
"I think the odds favor us getting over this and going back up to where we were," Paulsen said. "My bet is that we have not shut down the speed of world growth yet."
Some analysts are far less sanguine. Many of them rely on the relationship between a company's share price and its earnings to determine whether it is over- or undervalued, and they say that rapidly rising corporate earnings were the crucial engine behind the stock market's long rise from late 2002 through the first part of this year. S&P 500 companies are trading around 15 times operating earnings, well below where they were at the last market peak in 2000.
But some analysts are worried that high energy prices and the possibility - also mentioned by Bernanke last week - of a cooling economy could combine to make it harder for companies to post strong earnings growth.
"Earnings are going to be a little harder from now on," said Peter Jankovskis, director of research for OakBrook Investments LLC. Though he thinks the current drop is a correction rather than a bear market, he said small investors with extra money in their pockets might do well to put it in a money market fund or high-interest bank account until the current trend becomes clearer.
"The market definitely has cycles: Sell in May, stay away. Markets are generally weak in the summer," he said. "It won't hurt you to stay on the sidelines for a while."
On the other hand, investors who are already invested in equities shouldn't run for the exits, market watchers said.
"The worst thing that can happen is that people panic at the bottom, and it takes them a year or two to get over that panic. By that time, you've missed most of the next bull market," said Ken Tower, chief market strategist for CyberTrader, a Charles Schwab Co. subsidiary that focuses on active traders.
