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BARRON'S:
The Trader
Investors Ponder
Risks-of Not Being In The Market
By Michael
Santoli
For all the dangers
that war might loose in the Middle East or that an
unresponsive economy could thrust upon the stock market, plenty of investors
are
more preoccupied with "upside risk."
That's the perceived hazard of missing a potential rally in stocks should
the
U.S. lead a swift military victory in Iraq, trigger a collapse in oil
prices and
make the world safe for another bull market, or at least a rush toward
the top
of the recent trading range.
Stocks have struggled in the three weeks since corporate earnings season
began, and the negative action has suggested to some that the old October
lows
are exerting a strong downward pull. Yet even after sustaining a couple
lopsidedly weak days last week, and while ruminating over the likelihood
of war
within weeks, traders bumped the broad market appreciably higher Friday.
The broad unwillingness to sell aggressively or consistently lends weight
to a
common remark heard from fund managers: That they must "participate"
in the
upside if the market rallies to the sound of bombs falling.
With a gain of more than 108 points Friday, the Dow Jones Industrial
Average
narrowed its loss for the week to just 77 points, or 0.9%, leaving the
index at
8053 after trading below the 8000 mark at some point during each session.
The
Standard & Poor's 500 index slipped 0.6% to 855 and the Nasdaq pulled
back by
1.6% to 1320.
If lead changes are the mark of excitement in a ballgame, the same standard
would suggest that last week's market was a riveting contest. During
each of the
five days, the Dow at some point traded both above and below the prior
day's
close, as players assimilated the President's firm State of the Union
address
and absorbed hundreds of important profit reports.
Though economic clues and earnings releases were shoved from center
stage by
the increasing suggestions that fighting could soon start in the Persian
Gulf,
there were enough encouraging numbers Friday to engender some hope domestically.
Walt Disney outdid expectations for a change, Honeywell divested a troublesome
division and a measure of Midwestern manufacturing activity was unexpectedly
encouraging. The Dow drew strength from all three as the week ended.
These upbeat notices helped dispel the bad taste left by AOL Time Warner's
monstrous $98 billion annual loss and asset writedown, as well as disappointing
results from Altria (formerly Philip Morris) and its Kraft Foods subsidiary.
The overall pattern of corporate profit performance remained intact,
with the
usual 60% of companies exceeding forecasts by about the historical norm
of
around 3%. Yet more than half the companies that have offered hints
about the
remainder of the year have guided earnings expectations lower, dampening
the
enthusiasm for a sharp, quick fundamental recovery that helped stocks
spurt
higher to start the year.
According to the earnings trackers at Ehrenkrantz King Nussbaum, the
332
earnings pre-announcements issued so far for the current first quarter
of the
year have been weighted toward the negative. The 2.3 ratio of negative
to
positive foreshadowings ranks as the worst at this stage of the quarter
since
the third quarter of 2001.
In all, Wall Street is still predicting S&P 500 companies will increase
earnings for all of 2003 by just under 13%. Yet more and more of that
projected
growth is being pushed later in the year.
The idea that earnings
and stock prices are being suppressed by commercial
paralysis due to impending war, and will rocket higher toward mid-year
once Iraq
is dealt with, is a solid consensus view right now. Charts illustrating
the Gulf
War experience in 1991, when the market soared the moment hostilities
started,
are ubiquitous, as is the comment that in `91 the rally was so sudden
there was
no time to get in. Thus, goes the logical conclusion, investors should
position
themselves to capture a rally now.
There is a bullish
dream scenario that's not entirely implausible, consisting
of an invasion of Iraq and rapid collapse of Saddam Hussein's army and
regime,
followed by a celebratory market rally and a jolt of animal spirits
that will
quicken business investment and lead to a new peace dividend.
It's a lot to ask for in a messy and dangerous world, but who's to say
it
can't happen that way?
Yet it seems clear that one reason the '91 model retains such a hold
on
professional investors' imaginations is that it stands as the moment
when the
flint was struck to spark the roaring 'Nineties bull market.
It only gained
that distinction in hindsight, when the huge and continuous market gains
of that decade proved the Gulf War as one of the great all-time buying
opportunities.
Distinctions between then and now are important, though. The market
leading up
to the earlier war fell about 20%, then merely regained all that lost
ground in
a hurry by the time of the cease fire. Today, the market is up more
than 10%
from its recent low.
In 1991, stocks were far more cheaply priced relative to earnings. Inflation
and short-term interest rates then were far higher than today's, leaving
tremendous room for rates to tumble and inflation to cool, thus helping
to
sustain the upward move in share prices. Perhaps most important, the
forceful
rally back then was unanticipated, which helps explain why it was so
powerful.
It makes sense to expect that a decisive military win or an unexpected
abdication by the Iraqi dictator would drive a ferocious emotional buying
spree
in the market.
The question is whether
it would be the start of something so enduring that missing it would
be disastrous, or just a nice bounce in a range-trapped market that's
still challenged by mixed fundamental prospects.
Says one Wall Street trader who spends his days speaking with professional
investors: "Everyone wants to believe this is the low. The market
is behaving
just like it did last January."
More than two months ago, with the indexes slightly above current levels,
the
market's tone was described here as emotional, irresolute and suggestible;
it
remains so.
-- The traditionally defined and ritually anticipated January effect,
in which
smaller stocks tend to do better than large ones during a year's first
month,
wasn't very evident this year.
Smaller stocks, in fact, lagged larger names for the month. The S&P
Small Cap
600 index fell 3.4%, more than the 3% loss in the S&P Mid Cap 400
and the 2.7%
decline in the big-cap S&P 500. This is the second consecutive year
in which
this traditional version of the January effect failed to materialize.
It was also the second straight January in which the major indexes lost
ground. Another of those dusty Wall Street guidebooks holds that the
direction
of the market in January foreshadows the entire year's movement. The
bear
market, of course, has delighted in tearing down such guidelines and
rules, so
the value of this sort of platitudinous wisdom has been diminished.
There are
better reasons to be concerned about a down year than this.
But the outperformance of larger stocks seems related to a few broad
forces
out there. For one thing, small stocks have held up far better than
big ones for
nearly three years, indicating the small-cap cycle is rather mature.
The rapidly
weakening dollar also acts to the advantage of bigger multinational
firms.
Subpar economic growth and scarce pricing power is exacerbating the
winner-take-all nature of many industries, favoring efficient low-cost
producers
with scale advantages.
Other explanations include the lack of much tax-loss selling last year,
given
that few investors had lots of profits to offset. Tax-loss selling typically
sets up a rebound of small shares around the turn of the year. Also,
cash hasn't
flowed into stock funds as it usually does at the start of the year,
depriving
the January effect of some fuel. Finally, plenty of experts say
the effect has
become too widely anticipated and occurs months early these days.
Brian Belski, strategist at U.S. Bancorp Piper Jaffray, notes the relative
valuations. The valuation of large caps, as measured by the Russell
1000, is
near a 10-year low versus the small-cap Russell 2000 based on price
to expected
earnings and price to cash flow, he says. Belski also thinks professional
investors are sticking with larger, more liquid names -- especially
tech shares
-- as a way to play any potential rally while retaining the ability
to sell them
quickly.
In fact, the continued willingness of investors to own tech stocks allowed
the
Nasdaq to perform better than the broader market last month. This, some
argue,
is a separate element of the January effect, when more speculative issues
do
better than stable ones.
While investors keep at least a little mad money in the technology area
to
ensure participation in any emotional, post-war rally, many are simultaneously
looking for "places to hide," says Belski.
The search for properly guarded redoubts is made more urgent by the
fact that
one of the favorite and most effective hiding places of the last two
years --
banks, especially large regional banks -- appears to be under assault.
Financials have grown to comprise about 20% of the S&P 500 and of
very broad
indexes like the Wilshire 5000, a record high weighting for the group.
Investors
have flocked to the stocks because of their relative predictability,
decent
dividend yields and ability to thrive as interest rates fall.
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