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Specter of the Bear Still Looms

Fresh 237-Point Dow Loss Shows Deep Fear Holding Stocks Back

October 01, 1998|TOM PETRUNO

Wall Street's bears apparently couldn't resist adding insult to injury on Wednesday, taking another hard swipe at stocks as the worst quarter in eight years came to a dismal close.

The Dow Jones industrial average slumped 237.90 points, or 2.9%, to end at 7,842.62. That capped a quarter that saw the blue-chip index close as low as 7,539.07 on Aug. 31--a 19.3% plunge from its July 17 record high--nearly but not quite qualifying as a genuine bear market, by Wall Street's usual bear-threshold rule of 20%.

As a further reminder of how dramatically investor sentiment shifted in the third quarter amid the most serious global financial crisis since at least 1990, the bellwether 30-year Treasury bond yield tumbled to a record low close of 4.97% on Wednesday, down from 5.09% on Tuesday and the first finish ever below 5%.

What stocks' latest slide--and T-bonds' spectacular rally--say loud and clear is that many investors still are terribly averse to taking on risk, and would rather put their money into things they perceive to be super safe.

And some market veterans say that makes good sense, even with stocks worldwide having fallen to levels which, for many individual securities, may constitute great long-term bargains.

Getting ready to write his third-quarter wrap-up for clients on Wednesday, Charles Henderson, chief investment officer at Chicago Trust Co., admitted that he was "having a hard time coming up with anything positive to say."

Yes, the Federal Reserve Board cut interest rates on Tuesday for the first time since early-1996. Yes, individual investors, on balance, were buyers of stock mutual funds again in September, after pulling money out in August.

And yes, the currency and market crises in many emerging economies worldwide seem to at least have stabilized in recent weeks.

All three of those factors helped the Dow bounce up from its lows to pare its loss for the quarter to 12.4%--leaving it down 16% from its record high.

Smaller stocks, battered mercilessly in August, have been rebounding faster than blue chips in recent weeks. The Russell 2,000 index of smaller stocks lost 20.5% for the quarter, and is down 26% from its peak. But at its Aug. 31 low the Russell was down 31.2% from its peak.

What continues to trouble many market pros, however, is the fundamental outlook for the economy and for corporate profits.

Current Wall Street analyst estimates have blue-chip U.S. companies' earnings declining 2.1% this quarter from a year ago.

Corporate profit warnings have continued in a steady stream in recent weeks, as weakening economies abroad and tougher competition domestically continue to depress the earnings outlook.

What's more, analysts have only begun to trim what many market strategists say are outrageously high earnings expectations for the fourth quarter and for 1999.

The bottom line, say many pros, is that the bottom line is in trouble. "That's where I'm not optimistic in the short-term," said Ned Riley, investment chief at BankBoston.

The questions investors must wrestle with are how bad the earnings situation will get (i.e., is it worse than we think?), and how far off a profit recovery may be.

Normally, of course, lower interest rates--courtesy of the Fed--would be a tonic for stocks, and would bolster the share prices investors are willing to pay relative to earnings.

But this time, many experts question whether stocks' price-to-earnings ratios--which in the case of many blue chips, at least, still are well above historic norms--should go higher if the reason the Fed is cutting interest rates is because it sees the risk of a deflationary cycle worldwide.

Indeed, that's what is different this time around from other bear markets, or near-bear-markets, Wall Street has suffered since 1946. It used to be higher inflation investors had to fear. Now, the concern is deflation--a downward spiral of goods and services prices, profits and asset values, rooted in too much industrial capacity worldwide and not enough buyers.

That was Gillette's message this week, in announcing massive layoffs amid disappointing sales in many foreign countries. Gillette stock, not long ago a premier holding, has already plunged 39% from its 1998 peak, to $38.25 now.

Could the broader U.S. market suffer a decline that sharp? The bulls insist that, bad as the third quarter was for stocks, it doesn't signal bigger trouble ahead for the U.S. economy. They see corporate earnings improving in 1999 after a rough 1998. They also point out that the Standard & Poor's 500 index still is up 4.8% year-to-date.

But even many 1999 optimists worry that key indexes like the Dow will soon retest the lows they saw in late August, perhaps as more investors opt to recognize this year's portfolio losses and clear the decks for the new year.

What's more, the situation overseas remains fluid, to say the least. Tokyo stocks hit new 12-year lows overnight. Latin America still is vulnerable to a continuing wave of capital outflows. Russia is a mess.

But did the third quarter itself constitute a bear market phase? The Dow, as noted, didn't cross the 20% loss threshold on a closing basis.

Eugene Peroni, a market technician at Janney Montgomery Scott, argues that this is only a "correction" thus far, because he sees investors still willing to commit new cash to some stocks, albeit classic "defensive" issues such as utilities, drug shares and tobacco shares.

For the vast majority of stocks, however, the bear has clearly arrived in 1998, not only here but in most markets worldwide. How long he decides to stay remains to be seen.


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Coming Sunday: A quarterly primer on personal finance, with investment steps to take.

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