26 Jul 2002 The Bottom?
What did Wednesday’s 500-point rally mean? Event the bears can’t ignore the largest gain in 15 years – some discussion is warranted. Was it the bottom of a long decline, was it a reflex action, did it mean anything at all? One of my favorite writers, Caroline Baum of Bloomberg put it this way: “a) the two houses of Congress agreed on a bill to overhaul existing securities and accounting laws; b) the sight of Adelphia Communications’ John Rigas and his two sons being led away in handcuffs reassured investors the government is getting tough on white-collar crime; c) sellers took the day off; d) after a month of losses making July 2002 resemble October 1929, even the deadest cat can bounce; e) all of the above; f) none of the above.”
There were perhaps two other supporting reasons for Wednesday’s rally. There were persistent rumors throughout the day that the Fed was in secret meetings and speculation that they might lower interest rates yet again. Fed funds futures actually priced in a rate drop before the next meeting. The second reason was suggested on the floor of the New York Exchange as specialists said that fund managers might have begun re-balancing their portfolios to meet asset-allocation models as stock positions have declined while bonds have increased over the past couple of years.
Whatever the causes of the rally, it happened. Our portfolios experienced increases between 6 and 10% that day. Every stock in them rose. Even though it was only for a day, the rally encouraged investors that there are buyers out there, that values are compelling, and that the market does remember how to go up.
Stock prices and the markets as a whole continues to be very volatile and that will likely remain the case for months to come. A few bears continue to insist that ‘CAPITULATION’ has not yet been achieved and is necessary. They probably mean that several more days of 200 to 300-point declines followed by a month or more of grinding around at those new depths to form a market bottom. The selling would have to be indiscriminate and panicky, not unlike the past few days. While the necessary duration of bottom-formation is debated, few argue its necessity. Bottom formation actually builds a healthy foundation for the next bull phase. If the market is less deliberate and wanders aimlessly up and down in a state of malaise for months to come, the action could jeopardize the economic recovery. The former case seems to be happening.
Another area we will watch closely is government policy. The federal government seems to be moving in pretty much the right direction these days. Worries of their overreaching with restrictive new policies appear to be abating as both the House and the Senate have enacted new accounting oversight regulations. The political noise over the issues of corporate fraud will continue, but the market will likely take solace in the fact that the uncertainty of what goes on behind congressional committee doors has been replaced by the fact of law that will likely be signed by President Bush shortly. Markets don’t like uncertainty, especially that surrounding government policy.
While the federal government is acting responsibly, states have a role to play as well. Not wanting to be left out of these historic times, leave it to Boston to fire the first really dumb shot. The Massachusetts Senate voted yesterday to override Acting Governor Jane Swift’s veto of more than $1 billion in tax increases that include the largest personal income tax increase in the U.S. so far this year. Raising taxes during periods of economic weakness is the LAST thing government should do. If other state governments follow suit in railing taxes after failing to cut spending, our consumer-driven economy could have the wind knocked out of its sails.
“It’s the Economy Stupid”
The economic statistics released this week were, on balance, pretty good. This is a relatively strong economy and it is creating jobs. Initial jobless claims dropped by 17,000 during the week of July 20th, and the measure was 23,000 better than expected. Inflation remains tame, giving the Fed maximum latitude to keep interest rates at historic lows to continue to stimulate the recovery. New home sales surged another million units in June, 21,000 more than expected. Existing home sales of 5 million showed a 75,000 home decline, but are still at very healthy levels.
Durable goods orders were down 3.8% compared to an expected increase of .6%. That drop shows that the recovery may be slowing, but no major economist I follow seemed too concerned by the drop. It is likely the result of transition from the huge inventory-rebuilding phase of the first quarter to maintaining inventories to meet current demand, which is relatively sluggish.
Our economy has weathered unprecedented storms; the bursting of an asset bubble, a 2 1/2-year bear market, and the unprecedented terrorist attacks last September, with only one quarterly contraction in real gross domestic product (the third quarter of 2001), pending revisions. If the economy can weather storms like these, we have every reason to feel confident in its future and that of the market. As you know, markets are emotional in the short run and logical over the longer cycle. Over the longer view (six months to a year), earnings guide stock prices. Today stock prices are CHEAP relative to the very real and very good earnings that are being reported as you read this Brief.
The market bottom may have passed or may be ahead, but it is likely near. No doubt your emotions have been racked and tested by these horrible last few weeks as have mine. Machiavelli could not have devised a better torture than being forced to watch our companies report good earnings news only to be rewarded by vicious selling by traders or worn-out investors. In the midst of it all, I am so thankful for you and your collective patience through this mess. Each one of you should get a spot on CNBC to herald your perseverance during these trials and to acclaim your confidence in the ultimate integrity of America’s free market system.