19 Jul 2002 Is that a Towel in the Ring?

Think back to March of 2000 and you might recall those strong the public statements that were bandied about by the government’s Microsoft trustbusters.  Their tone of retribution was the impetus, in the opinion of many, that launched the first phase of the ‘great bear market of 2000 to 200?.’  The question that keeps me awake at night is this; could the bear be prolonged indefinitely as our congress and administration posture to ‘reform’ securities laws, and in so doing, drive away investors and CEOs who fear that the new regulations will be too restrictive to promote effective capital formation or excessive penalties?  It is plausible that the markets are not so worried that every company is crooked as they are that Washington will overreach in addressing a problem that is not as widespread the big-government proponents would have us believe. 

Government did not create the problems of fraud and deception being revealed at the highest levels of corporate America.  Our corruption woes are the byproduct of a dramatically profitable and lengthy period of economic expansion.  Anyone who understands human nature is not surprised that greed would rear its ugly head sooner or later in the wake of the huge profits of the 90’s.  But I think we were all shocked at how easily and effectively the perpetrators carried out their acts, and particularly the grand scale some achieved.

The forces of at least four components of a ‘perfect storm’ currently buffet the market.  The crisis in confidence is foremost on everyone’s mind.  It is the subject of talk shows, op-ed columns, and political rhetoric, both here and abroad.  The second component is less apparent, but I believe is a significant cause of market weakness today – the fear of government over-regulation.  Third, we are in the midst of corporate earnings announcements.  Almost half of the S&P 500 companies have reported.  The good news of earnings is ignored while bad news is exaggerated, sometimes dramatically.  Finally, the tension of terror, possibility of at least three wars, and other major global events continue to drown any attempts of the market to pull clear of the other three storms.

While virtually every market sign indicates the market downturn is nearing an end, one wonders how it can overcome the sum of the issues it faces now.  Indeed, several recent attempts at rallies have been put down like peasant revolts.  The indiscriminant selling has knocked down even the hero stocks of the last few months.

So if the market fails to recover soon, what does that do to the consumer, the stalwart of this economy?  So far, the market’s collapse has not had a measurable impact on the consumer.  Many have worried that recent surveys point to a drop in consumer confidence, but consumer spending remains strong.  As Greenspan pointed out Wednesday in his congressional testimony, what the consumer DOES is much more important than what he says, and what he continues to do is to spend.  But one has to wonder when the reality of 6 trillion dollars of value evaporating from the equities markets will exact a greater toll on consumer behavior.

Retail numbers, the result of consumer spending, continue to be strong.  All of our retailers continue to report very good weekly and monthly sales figures, but you wouldn’t know it by their stock prices.  For example, Best Buy reported that their latest quarterly earnings were up 27%, but the stock declined 18% since making the announcement.  Bed Bath & Beyond reported an earnings gain of a whopping 50%, but their stock has been punished by 11% since posting the news.  Ladies fashion retailer, Chicos posted earnings gains of 53% in their latest quarter, only to watch their stock decline by 18% in the weeks following the announcement.  One might be wondering if these companies are overpriced and are being sold as investors fear these are the last good reports.  Each of these companies is valued VERY favorably compared to their own historical measures as well as those of their competition and the market as a whole.  In fact they report that the quarter ahead looks more promising that the past quarter.

So why are stocks like these going down?  It’s a bear market.  People are scared and they don’t want to be in stocks.  Some Wall Street experts say this is not capitulation (massive throwing in of the towel) because the retreat is too orderly.  Well it surely feels like capitulation where I sit.  In fact, the American Association of Individual Investors survey flashed the highest bearish sentiment in the last three weeks of any time since mid-1992.  In EVERY case that the bearish sentiment over a 3-week period has been this high, the market was at a major bottom.  The last two weeks have seen even the market’s winners take it on the chin.  Housing, real estate, retail, and HMO stocks have all experienced dramatic selling pressure.

I’ve experienced bear markets, even long ones like the 70’s.  But this one is unique because it’s right in the middle of the information age.  Everybody’s got a computer, a television, real-time quotes and portfolio balances, access to investor websites, and online chat rooms.  Rumors travel as fast as facts and they can move even the largest of companies, just as if the words came from the mouth of Alan Greenspan himself.  Company information is no longer filtered through analysts who understand the operating and accounting subtleties of companies and industries.  Rather, because of SEC Regulation “Full Disclosure,” company results are dumped on the investing public in raw and unabridged form, with little or no interpretation or guidance from the company’s management.  Volatility increases as inexperienced investors sell first and ask questions later.  In bear markets, even experienced investors fall prey the phenomenon of stock prices indicating value rather than the other way around.  But that is a short-term phenomenon and it does not last forever.

We may or may not be at a selling climax.  But each time I thought we were at a turning point in the market, it proved to be a trap.  Yet another component of the ‘perfect storm’ was just over the horizon waiting to deliver a knockdown punch.  It now looks like there are so many forces aligned against the market that any sustainable recovery is doubtful.  We are making necessary adjustments in the portfolios to stem their losses and to sustain them in the event of a continued and prolonged bear market.  But we remain mindful that these are the precise conditions that spawn great bull markets.  We remain on ‘heightened alert.’