Tom Lauricella | April 03, 2008
AFTER the beating the stock market took during the first three months of this year, one question seems to be on everyone's mind.
Is it over?
The first quarter was one for the history books. The Dow Jones Industrial Average finished March down 7.6 per cent from where it started the year, at 12,262.89, marking its worst quarter in five years, since the depths of the tech-stock bust.
Shares were driven south by the never-before-seen turmoil in the bond markets that climaxed with the dramatic collapse of Bear Stearns, one of Wall Street's biggest firms, and forced unparalleled actions from the Federal Reserve in order to shore up the financial system.
Over the past three months, the Dow lost 1001.93 points, its largest first-quarter point decline in the history of the index.
Meanwhile, the five months of losses on the Standard&Poor's 500-stock index mark that benchmark's longest losing streak since October 1990.
But it's anything but clear as to whether stocks have hit their lows. When the first quarter began, many on Wall Street thought the US economy would avoid recession.
Now the debate is over how long and how deep the downturn will be.
At the start of the year, corporate-profit growth was expected to slow, but remain positive. Now, first- and second-quarter earnings are expected to decline, and the unknown is whether an expected big rebound in the second half of the year will materialise.
A number of optimists on Wall Street think the turning point will come sooner rather than later, thanks in large part to the Federal Reserve's aggressive efforts to stabilise the financial system and reduce short-term interest rates.
Pessimists contend that job losses are only just beginning, and home-price declines appear to be accelerating.
Meanwhile, raw-materials costs remain stubbornly high, despite the slowdown in the US economy, which will likely pinch consumers more and crimp corporate profits.
These market watchers say the bulls are jumping the gun.
After its first-quarter decline, the Dow is down 13 per cent from its record close of 14,164.53, hit October 9 last year. The Standard & Poor's 500-stock index, which has a heavy weighting of financial stocks, took a bigger hit in the first quarter, losing 9.9 per cent to 1322.70, and is down 16 per cent from its October record.
The Nasdaq Composite Index, which outperformed both the DJIA and S&P 500 in 2007, lost 14 per cent during the first quarter and is down 20 per cent from its recent high in October.
The Russell 2000 index of small-company stocks, which are seen as most vulnerable to a recession, is down 10 per cent this year and has lost 20 per cent from its most recent high.
These losses occurred against the backdrop of volatility in the stock market not seen since the worldwide economic slump that began with the stock market collapse of October 28-29, 1929, and continued through most of the 1930s. The S&P 500 moved more than 1 per cent on 51 per cent of the trading days in the first quarter, the biggest percentage since 1934 and the fifth-largest percentage in the index's history.
Although it is small comfort to investors toting up their losses for the first quarter, the Dow and the S&P 500 have not reached the 20 per cent peak-to-trough decline that is the traditional definition of a bear market. Both indexes hit their lows for the quarter in the days before the collapse of Bear Stearns, amid concerns that the entire financial system was in danger of seizing up. On March 10, the Dow closed down 17 per cent from its October peak, and the S&P 500 finished down 18.6 per cent from its high.
Since then, the Dow has rebounded 5 per cent and the S&P 500 has bounced 4 per cent.
If stocks do not pierce their March 10 lows, and if it turns out the US economy is in a recession, it would be the first time since 1961 that an economic downturn is not accompanied by an official bear market (a bear market did start in December 1961, but that was after the recession ended. There also have been bear markets that did not coincide with recessions). The bounce that thus far has kept the Dow and S&P 500 from bear-market territory is largely the result of the Fed's moves to improve liquidity in the credit markets, such as giving brokerage firms access to short-term loans from its lending window. In addition, since the start of the year the Fed has slashed the key federal-funds rate to 2.25 per cent from 4.25 per cent, and it backed JPMorgan Chase's deal to acquire Bear Stearns.
The Fed's role in helping Bear Stearns avoid bankruptcy, though it remains contentious, was interpreted as a sign that the central bank would take whatever steps necessary, if officials believed the financial system was in danger of unravelling.
"The risk of that happening has gone down substantially," said Binky Chadha, chief US equity strategist at Deutsche Bank. The Fed's actions "reduced the downside risk" for stocks. Mr Chadha is among those who believe a bottom for stocks is near and that a rebound could begin as soon as this month, based on his belief that the US economy is midway through a two-quarter-long recession.
When Brian Rauscher, market strategist at Brown Brothers Harriman, goes sector by sector through the market, he does not see enough bullish indicators in place to suggest the market is ready to begin a sustained rally.
But he also does not see a big push to new lows in the S&P 500.
"For someone to be really bearish, they have to make the case that earnings are ready to collapse ... and that the economy is really collapsing," Mr Rauscher said. "That isn't evident to me right now."
But Subodh Kumar, who heads up Toronto-based Subodh Kumar & Associates, sees a potential problem for the market. He argues that earnings estimates will be revised lower as companies report first-quarter results and provide forecasts for the rest of the year. Until the market reflects that, he does not think stocks have hit bottom.
Still, Kumar does not think the bottom is far off. "The market will set a low in the second quarter, and from there we'll set a new cycle in late 2008 and into 2009, driven by an earnings recovery and accommodative central banks," he said.
The Wall Street Journal