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Sailing in rough waters
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October 14, 1998: 1:21 p.m. ET
Wall Street's ride in the past months has been choppy at best. What's next?
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NEW YORK (CNNfn) - When the first signs of the Asian crisis hit home last October and the Dow plunged 554 points, investors stormed back into the market like shoppers on the day after Christmas.
A year and a few harrowing stock market rides later, many of the bargain hunters are starting to wonder if their buying binge was such a good idea.
What has changed? For one, what started as a small ripple in Thailand in the summer of 1997, has grown to a tidal wave, engulfing markets all around the globe. First Hong Kong, then Indonesia, then South Korea and finally Japan fell victim to the contagion, their economies stalling or falling and the region's currencies melting away.
Once the damage was done in Asia, the storm moved to Russia and Latin America, and finally the last "oasis of prosperity" -- the economies of the United States and Western Europe.
For the first time in years, central bankers and economists are mentioning the word 'recession'. The Federal Reserve, which up to now had been guarding against inflation, abruptly reversed course two weeks ago and cut short term interest rates to prevent the slowdown from deepening.
The U.S. economy, which grew at a torrid pace in 1996 and 1997, is starting to get creaky. And, while unemployment is still low and inflation is absent, consumer confidence is starting to decline, corporate layoffs are picking up and investors are pulling money out of the market for the first time in years.
For many investors, the economic turmoil is unsettling to say the least, particularly when they see the value of their portfolios cut in half.
"Between both my husband's and my investments, since August 31, we have lost $40,000 in value from our retirement accounts," one investor wrote CNNfn. "...The money we lost was equivalent to one year's salary for me. It's almost as if I worked a year for nothing."
Whispers of recession
Last week, J.P. Morgan, the fourth-largest commercial bank in the United States, became the first major financial institution to predict the United States will slip into a recession next year.
Barton Biggs, the chairman of Morgan Stanley Dean Witter Asset Management, also expects recession and negative corporate earnings to be the theme of 1999.
"The process goes further and is much more painful than rational people can imagine. I think many are still too optimistic about how quickly the contagion can be arrested in the West, and I expect a recession next year, with corporate earnings not up, but down," Biggs wrote in a recent paper.
Others are still cautious in their predictions, daring only to say that a sharp slowdown in economic growth is certain next year. But will the slowdown turn into negative growth?
"I think there is a 40 percent possibility that we will hit a recession next year," said Marshall Acuff, portfolio strategist at Salomon Smith Barney, the investing arm of Citigroup.
And the United States is not alone.
Jeffrey Applegate, chief investment strategist at Lehman Brothers, thinks about a quarter of the world's economy will be in recession next year, up from a fifth in 1998, a fact that is certain to stifle growth at home.
"Our 1999 (U.S.) GDP forecast was cut to 0.7 percent from 1.8 percent," Applegate wrote in a research paper this week.
That's a far cry from the robust 5.5 percent growth reported in the first quarter of 1998 and expectations for a 3 percent growth rate for the full year.
Have the bears woken up?
How has the stock market reacted to all this? You guessed it, not well. The Dow industrials, which gained more than 12 percent in the first quarter and peaked at 9,337.97 in July, have seen nothing but jitters since then. The index, the most closely followed indicator of the health of Blue Chip America, is now down nearly 15 percent from its July high and is barely holding on to a gain of less than 1 percent for the year.
(Click here for a detailed timeline of the Dow's performance.)
But the Dow only reflects the performance of 30 large, established companies, whose records show years of strong growth, stellar earnings and solid finances. And if you think the performance of this exclusive club of market blue bloods has been shaky, take a look at the Nasdaq Composite, the S&P 500 and the Russell 2000.
The Nasdaq, a bellwether indicator of how technology stocks are doing, is down 25 percent from its July high of 2,014.25 and down nearly 4 percent for the year. The S&P 500, the broadest gauge of the market's performance, is off more than 16 percent from its July peak at 1,186.75 and holds a meager 2.5-percent gain for the year.
The picture is by far most dismal for the Russell 2000, a broad measure that shows how smaller companies are doing. The Russell hit an all-time high at 491.41 in April and has been on a steady descent ever since. The index now stands nearly 35 percent below its high and has a loss of almost 27 percent for the year.
Making things worse, small-time investors, working Americans who are saving money for retirement or their kids' college education, and who were behind the stock market's soaring rally in the past three years, have started to take their cash out of stocks. According to the Investment Company Institute, the mutual fund industry's association, stock market funds' assets dropped 15.9 percent between July and August, as prices tumbled and investors pulled a whopping $11.2 billion out of the funds in one month.
"Speaking of financial markets as a whole --stocks, bonds and the dollar -- 'volatile' is not strong enough a word to describe them," said Hugh Johnson, chief investment officer at First Albany.
Volatile, yes. But is this a bear market? And if so, how long will it last and how bad will it get? That's where the market gurus, whose words of wisdom even the ficklest of fickle investors sometimes follow like a group of obedient children, seem to disagree.
What the experts say
Most of Wall Street's raging bulls have by now been silenced, some turning into voracious bears, some into timid calves. But there are also those who see a silver lining in the thunder and those who say this is a chance to buy a discount ticket for a long-term market joy ride.
Take for example Ralph Acampora, the feisty chief technical analyst at Prudential Securities, whose words have been known to cause wide market swings and who has changed his views at least three times this year.
Acampora started the year by trimming his predictions and blaming the Asian crisis for the market's woes. At the end of Wall Street's robust first quarter, Acampora was back, calling for the Dow to hit 10,000 and getting in the market "big time." Then in early August, Acampora turned bearish, predicting a 15 to 20 percent drop for the Dow from its highs. The day he spoke, the Dow fell nearly 300 points. Finally, last week, the now solidly bearish Acampora, lowered his target trading ranges to 6,500-7,000 for the Dow and 745-870 for the S&P 500.
Still, despite the doom and gloom he sees in the short term, Acampora advises gutsy investors to start sniffing out bargains in the market.
"The good news about the market's July to September 1998 decline is that so far it has created quite a bit of value, especially in the large capitalization area. It is now time for those who have a long term perspective to start picking through the rubble of the past several months and identify those groups and stocks that hopefully will bottom out in the weeks ahead and will become new investment vehicles. Start your search now," Acampora wrote in his latest market comment.
Goldman Sachs' Abby Joseph Cohen, a surviving bull, who also has a cult following in the market, has taken a similar approach. In her latest piece of advice to investors, Cohen lowered her earnings estimates for companies in the S&P 500. She avoided even mentioning her year-end targets for the Dow and the S&P 500, which she pegged at 9,300 and 1,150 respectively back in early March. Cohen still expects stock prices to rise to new highs next year.
But Salomon's Acuff is less optimistic. With most stocks trading on the New York Stock Exchange falling 40 percent or more from their 12-month highs, Acuff thinks this is an active bear market for which there are no quick fixes in sight.
"I think this could go on for another year or more. There is no short-term resolution of the major issues in sight," Acuff said.
He expects the Dow to settle in a range between 7,500 and 8,500.
Which brings us back to all the factors, big and small, domestic and global that are likely to influence the market for the rest of this year and in early 1999.
Where do we go from here?
With the economy slowing down, exports declining and companies starting to feel the pinch from the global market turmoil, corporate bottom lines are the first thing that's likely to suffer. After nearly three years of double digit earnings growth, Wall Street faces its first quarter since 1991 in which earnings are actually likely to decline from the same period a year earlier.
According to First Call, a firm that tracks Wall Street's earnings expectations, earnings for S&P 500 companies are likely to drop 3.2 percent in the third quarter. With the third quarter profit reporting season just heating up, that number is likely to shrink to only a 1 percent decline, still the worst quarter for the market since July-August 1991, according to Chuck Hill, First Call's director of research.
Although the picture looks somewhat brighter in the fourth quarter and at the start of 1999, Hill warned that many of the current estimates are likely to be trimmed, some significantly.
"The one thing you don't want to ignore is the stock market itself," said First Albany's Johnson. "It is sending clear signals... The market is saying: "Look folks, play it safe, play it defensive."
For example, financial stocks, some of the market's high fliers early this year, have been pummeled in the last three months and their latest earnings spell nothing but trouble. Three of Wall Street's largest powerhouses this week reported their worst performance in years.
Merrill Lynch, the Street's premier outlet, posted its first loss in nine years and shed 3,400 jobs in the process. PaineWebber and Donaldson, Lufkin & Jenrette, although still managing to end the quarter in the black, also saw their profits shrink. DLJ, suffering a $234 million trading loss in emerging markets, reported its worst quarter since the company went public in 1995.
Also looming over many Wall Street firms is their exposure to hedge funds, investment pools for the rich and powerful, some of which came close to collapsing as the global economic tornado ripped through markets from Asia to Russia and Latin America.
Johnson says financial and other consumer oriented stocks, like airline and technology shares, are likely to suffer further commotion. But defensive market sectors, like pharmaceuticals, food retailers and utilities, should be sheltered from the worst.
What should investors do?
"Trying to manage money in this environment, you can't imagine how stressful this is," Johnson said.
His views reflect those of many a 401K and IRA investor, who have seen their nest eggs shrink from the size of an ostrich to that of a quail in just a few months.
So what should investors do?
"If you're an aggressive investor and can't sleep at night, then you should defend your portfolio by raising some cash and shifting into more defensive stocks," Johnson recommends.
But for those hearty enough to survive the turmoil and young enough not to have to worry about retiring next year, the advice is: "Hang in there. Maybe even buy some more."
"If you're not a day trader, I would say don't do a thing," Johnson said. "If you're buying for the long term, you'll be just fine."
His advice: look for companies whose earnings have consistently grown faster than the average S&P 500 stock and whose stock price has consistently outperformed the S&P 500. His recommended portfolio allocation: 52 percent stocks and 48 percent bonds.
"Every market sector has a lot of good companies in it," Johnson said.
Salomon's Acuff advises the same.
"Investors should revise their portfolios, but there is no room for panic at this juncture," he said. "Keep the stocks of good companies, those which are well financed and are leaders in their areas... This is an opportunity to buy quality companies on a weakness."
And Al Goldman, chief market strategist at AG Edwards, who thinks the market is 10 percent undervalued, says close your eyes and jump in, you'll be better off in the long run.
"Timing the stock market is always hazardous duty. Time in the stock market is critical to achieve long-term growth of your net worth. Our advice is do dive on in, the water and the time look fine," Goldman said.
As for who will save the market from its current woes, look up for Japan to fix its rickety banking system and breathe life into its economy through tax and interest-rate cuts, the Federal Reserve and its fellow central banks in the industrialized world to cut interest rates fast and far, the U.S. Congress to approve more funding for the IMF, and all those reeling emerging economies to stay the painful course to market capitalism. How long will it take? That's the subject of another story. 
-- by staff writer Malina Poshtova Zang
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