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How This Meltdown Stacks Up

With some indexes already surpassing the bear-market threshold, analysts are looking to history for clues.

September 01, 1998|WALTER HAMILTON | TIMES STAFF WRITER

Some key stock indexes may not yet officially show it, but make no mistake: U.S. stocks are caught in a bear market, and the only remaining question is how severe the damage will become, experts say.

The main blue-chip indexes--the Dow Jones industrial average and the Standard & Poor's 500 index--both are down 19.3% from their July 17 peaks. That is just short of the 20% decline commonly viewed as the bear-market threshold.

But after a ferocious plunge Monday that tore nearly 513 points, or 6.4%, from the Dow, Wall Street already is comparing this downturn with previous bear markets in the search for clues as to when it may end.

"Technically, is it a bear market?" asked James Stack, editor of the InvesTech Market letter in Whitefish, Mont. "It doesn't matter when your portfolio isn't in blue chips. You're already suffering bear-market conditions."

Indeed, the Russell 2,000 index of smaller stocks now has plunged a stunning 31.2% from its April peak.

But even as they assessed the damage Monday, some analysts said the market could be poised for at least a short-term snap-back.

"Very shortly, you're going to exhaust this wave of selling and get a pretty good rally," said John Hughes, a technical analyst at Shields & Co. in New York. "This selling smacks of a real panic, get-me-out-at-all-costs type of deal."

But where the ultimate bottom may be in this decline is anyone's guess. If history has shown anything, it's that no two bear markets are exactly alike.

In some ways, the current slide is almost identical to many earlier bear markets: It began with stocks being richly priced; smaller stocks began to weaken first, as investors flocked to "Nifty Fifty" large-cap issues; and it was heralded by rampant speculation in a particularly hot sector--in this case, unproven Internet-related stocks.

Nevertheless, this market decline is distinct both in the forces behind the sell-off as well as the relative speed with which it is occurring, experts say.

Unlike previous bear declines, the current slide hasn't been triggered by the usual forces of rising inflation and rising interest rates and an overheating U.S. economy, but rather by deepening world financial problems and the specter of deflation.

Some experts believe that's a positive: If the global financial turmoil can subside soon, then stocks might be buoyed by the fact that U.S. interest rates have been falling rather than rising. If a recession appears unlikely, then investors also may become more optimistic about U.S. corporate earnings growth, which has slowed this year but hasn't collapsed.

"An equity market decline associated with a recession and a big profit [contraction] very often is very difficult to reverse," said Christine Callies, chief strategist at Credit Suisse First Boston Corp.

What's more, it's widely believed that the Federal Reserve Board will cut interest rates significantly if recession worries deepen.

But some analysts worry that precisely because this decline has been fueled by events in foreign markets and economies, it isn't clear that the Fed could stave off a global recession with lower U.S. rates.

"There's no policymaker in a position to do anything about this," said Hugh Johnson, chief investment officer at First Albany Corp. "The problem is that this is not strictly a U.S. issue, and that's what bothers me. It's a global issue."

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The speed of the current correction is also noteworthy. The almost 20% slide in blue chips in slightly more than six weeks has come much faster than many other downturns.

The bear markets of 1973-74, when the S&P 500 fell 48.2%, and 1980-82, when it tumbled 27.1%, both lasted 21 months.

Though it's inflicting painful losses, the accelerating market decline of the last week has raised hope that this bear market will end relatively quickly. A more prolonged decline, some experts believe, could do much greater long-term damage to the market because it could devastate investors' psyches.

How can we know how much further stocks will fall?

From a fundamental viewpoint, analysts note that many stocks still sell for relatively high price-to-earnings ratios, at least historically. Just how cheap stocks will have to get may depend largely on how worried investors become about the 1999 economic outlook.

"I think it's bad because the market is coming off record valuations and [thus] you could have record declines" from those levels, said Ricky Harrington, a technical analyst at Interstate/Johnson Lane, a brokerage in Charlotte, N.C.

From a "technical" standpoint, meanwhile, many analysts are waiting for a so-called capitulation day in which selling becomes so frenzied that investors in effect tire themselves out.

That typically marks at least a temporary rebound. In the market's often contrarian ways, extreme bearishness is considered to be positive for the market.

Capitulation is thought to be a good sign because, as some investors dump stocks at any cost, others take advantage of the scattershot selling by picking them up on weakness.

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