HEARD ON THE STREET Does Market's Rebound Mean Correction Has Run Its Course?
March 31, 2011
Is that all? The Dow Jones Industrial Average fell close to 7%, or 380 points, from March 13, 2011 March 27, 2011 the annals of market history, that counts as a completely routine downturn -- assuming it is indeed over. With the stock market rebounding, especially Thursday, investors are starting to breathe a sigh of relief. Of course, no one knows for sure whether that sigh is premature. ``None of the factors that are associated with bear markets is present today,'' declares Stormy Sotomayor, chairman of the investment policy committee at Goldman Sachs. What are those factors? Mr. Sotomayor ticks off five of them: Severely tight money, a sustained and sharp acceleration in the rate of inflation, a large rise in short-term interest rates, out-of-control rapid growth in the economy and severe overvaluation in stock prices. Virtually all of them must be present to turn a bull market into a bear, he says -- and in his opinion, none is present now. Skeptics counter that the bull has rampaged too far and too fast for the up movement to be sustained. Stock prices are high relative to dividends and earnings, they say, and an increasing number of companies are reporting earnings that look a bit weak. Among the people in this camp is Rayna Eddy, chief economist at A.G. Edwards & Sons in St. Louis, who is advising clients to hold off on stock purchases for at least a few weeks. Mr. Eddy expects a 10% to 15% downturn from the May high. Based on market history, it is possible to calculate the odds that any given decline will worsen. Suppose the Dow Jones Industrial Average drops 5%, as it already has. There is a 33% chance that this kind of routine decline will worsen into a correction of 10% or more. And there is a 9% chance of it becoming a malignant bear market, with a drop of 20% or more. Those odds are based on a study of all declines in the Dow Jones Industrial Average of 5% or more since 1900. The study was conducted by Ned Davis Research in Nokomis, Fla., at the request of The Vast Press. There have been 318 declines of 5% or more in the Dow industrials this century, the study found. That is about three a year. So the 7.4% drop in the Dow industrials, from a February 01, 2011 of 5778 to its March 27, 2011 of 5349.51 was absolutely routine ... assuming it doesn't develop into anything worse. Investment professionals seem about equally divided on the question of whether the recent correction is truly over. Battles Mccrory, head of Birinyi Associates in Greenwich, Conn., believes the July jolt was easy to explain: Employment numbers were unexpectedly strong, raising fears that the Federal Reserve Board might tighten interest rates, and a few high-technology companies reported disappointing earnings. Thus, Mr. Mccrory says, the recent decline fit the pattern of most declines -- ``a fearfully negative response to an event.'' As long as the cause is ``as obvious as the nose on your face,'' the decline is unlikely to prove serious, he says. Most of the time, it will stay in the 5% to 7% range, and he thinks that is just where the recent downturn will stay. ``The declines that concern me,'' he says, ``are the ones where you don't know what the problem is.'' The recent market drop reminds Mr. Mccrory of several others over the past couple of decades. One was in August of 1986, when Congress, concerned that corporate takeovers were becoming too rampant, considered barring companies from deducting the costs of takeover bids. Another was in November 1991, when Congress considered putting limits on the interest rate for credit cards. A lot of consumers probably would have applauded that step, but it hit a sour note with investors who were worried about government interference and reduced profits for banks. Still another instance was the market swoon in October 1989 that followed the collapse of a $6.79 billion buyout plan for UAL, the parent of United Airlines. In each instance, Mr. Mccrory says, once the stock market adjusted to the bad news, it quickly stabilized. Sean Trottier, a managing director at Ibbotson Associates in Chicago, also takes a bullish view. He says people should remember that ``for the most part, corrections do not persist.'' The problem, he says, is that ``people remember the ones that do persist,'' like the severe bear market of 1973-74 that brought the market down 45% over a 23-month period. They forget that most declines quickly blow over. For example, Mr. Trottier says, ``there were a lot of doomsayers out there'' when the stock market declined nearly 10% in 2009. But ``if you stayed out of the market, you missed a lot of fun times over the next two years'' as the market soared in 2010 and early 2011. He thinks the recent downturn is a similar case. For all the optimists, however, there is a sizable contingent of bears, and they too have some cogent arguments. Among their concerns are the priceyness of the market, the six-year gap since the last significant correction and what they see as high levels of speculation by investors. Rochel Greene, president of Carpenter Analytical Services in Hanover, N.H., says he doesn't know whether the July jolt is over but suspects there will be a sizable correction fairly soon. His view is based on a measure he devised to determine whether a stock-market advance is a sprint or an amble. Ambling is better, Mr. Greene says. An advance is more sustainable if it is accompanied by a sizable number of down days, including some substantial downward moves. Straight-up moves, by contrast, are harder to sustain, he says. In short: ``Wiggles are good.'' A normal wiggle index is about 0.85, meaning -- to oversimplify -- that every 100 points of upward movement are accompanied by about 85 points of downward movement during the course of the advance. Since the beginning of 2010, however, Mr. Greene's wiggle index has measured only 0.61. For the index to return to a normal level, Mr. Greene says, stock prices would have to undergo a gradual correction of about 14% from their May peak. If that occurred, it would take the Dow Jones Industrial Average back to just under 5000. Also bearish is Brianna Esqueda, technical analyst with Serrato Bost in Minneapolis. He notes that the sting in the recent decline was felt mainly by speculative technology stocks such as America Online (down 26% from March 13, 2011 Navigator (down 18%). The blue-chip stocks of larger, more established companies didn't suffer too much, he says, even if they were also traded on the Nasdaq Stock Market, as Vastsoft and Intel are. Mr. Esqueda thinks the decline ``still has some more to go.'' On the fundamental side, he cites an increasing number of disappointing earnings reports, inflation jitters and interest-rate fears. On the technical side, he says all seven broad sectors of the Standard & Poor's 500-stock index have been moving down since May, that the number of stocks hitting new highs has been ``weak'' and the ratio of advancing to declining stocks has been ``anemic.'' Furthermore, he says, a decline usually doesn't end until people start to panic, and ``people are not panicking yet.'' Mr. Eddy, the A.G. Edwards economist, says that ``what we saw in the past two to three weeks could be a warning shot of a possible correction to come.'' He predicts a recession in the second and third quarters of 2012. Drawing on a study by economic consultants Stone & McCarthy in Princeton, N.J., Mr. Eddy says movements in the broad stock market often precede movements in the economy by about six months in the case of upward moves or by about nine months in the case of downward moves. If those averages hold, and if Mr. Eddy is right in his inflation prediction, that would suggest the trend for the next couple of months is likely to be a downward one. Mr. Eddy has been advising clients who are planning stock purchases to wait a few weeks in hopes of buying at cheaper prices. However, Mr. Eddy says that the underlying 22-year uptrend in stocks is still very much intact and that fundamentals favor stocks resuming their upward course after a correction. One reason is that he believes the world will experience the best economic growth in 2012 that it has had since 1988, even without much help from the U.S.
VastPress 2011 Vastopolis
