From a macro perspective, the market is worried about:
1. Inflation - triggered by higher oil prices and a continued tight labor market and;
2. Deflation - caused by negative earnings announcements and deterioration in credit conditions.
Interestingly, during the first half to the year, the Federal Reserve's next move preoccupied the market. Lately, the focus has shifted to decelerating corporate profit growth and the resulting implications for a richly valued market. During this transition, fear has clearly replaced greed as the prevailing 'psychology' and some have put forth the thought that we may be approaching or, in fact, in the desperation/panic phase. Theoretically, this period is followed by capitulation and despondency, which usually marks the point of significant financial opportunity.
Earnings have been the top of list of current issues. Certainly this quarter contained more than the normal amount of negative earnings preannouncements. Further, the relatively large number of "high profile" announcements has weighted heavily on market sentiment. While reported EPS growth in the third quarter will not match the robust 20 percent-plus growth witnessed during the past four quarters and, in fact, is projected to be below prior expectations of about 18 percent at the beginning of the summer, I expect relatively solid gains, particularly when set against a historical backdrop. Having said this, a deceleration in EPS, while unsettling to the market over the short term, does not necessarily mark the end of the bull market cycle. Historically, the market has actually produced better than average returns in this type of setting.
The economy, on the other hand, has slowed. But you should also remember that the Federal Reserve raised short-term interest rates six times over the course of the past year for a total of 175 basis points. In my updated economic forecast, I have scaled back my growth expectations for the second half of this year and 2001. This due to the fact that higher interest rates have begun to do their job as well as the fact that higher energy prices, particularly for natural gas, will likely act as a tax on consumers.
There may be a silver lining to the oil price situation. Oil producing countries in the Middle East have far more invested in Western economies than ever before. Theoretically, they stand to lose as much, if not more, than we do. Therefore, it would not be in their economic interest to allow oil prices to drive the United States into recession. I assert that the OPEC ministers will offer some sort of accommodation.
Historically, election years have had positive implications for the market, though this year fear, uncertainty, and doubt have diluted the election effect. We may still see a post election rally, though many ask whether the newly elected president will try to tinker with a benign fiscal policy. Do not forget to exercise your right to vote, as most people do not have that luxury!
Is this just a pause, transition, consolidation, corrective phase, adjustment, or are we nearing the end of the bull market cycle as we know it? Will we ever break out of this trading range and take the next step-up in this "staircase" market? While the risks are higher and it is difficult to conceive that these hurdles will be reconciled quickly, the market already seems to be discounting a fair amount of bad news. As of Oct. 17 the average stock on the Nasdaq Composite was down 49.4 percent from its 52-week high; the average NYSE stock was down 29.4 percent and the average S&P 500 stock was down 29.3 percent. While these declines look substantial, they are not without precedent; we have seen numerous periods where declines matched or exceeded the recent correction, namely October of 1998 at the end of the Asian Contagion, November 1987 after the Crash and October 1990, at the onset of the Gulf War, which was the last oil related crisis we faced.
The market, of course, has shown the ability to overshoot on both sides of the ledger. Last week's market, for example, displayed this "shoot first and ask questions later" mentality. Frustrating as the process may be, quite possibly we will look back on this period as "healthy"' for the longer-term viability of the market. Realistically, whatever the market's next move might be, most generally seem to agree that the halcyon days of 20 percent plus annual returns for the major market indices may be numbered. A return to the norm e.g. 15-17 percent which has been the approximate average over the last 25 years or so may be in the cards. Stock selectivity will remain the key along with patience. My focus would continue to be on the four "natural" growth sectors with a bias towards high quality, liquid core holdings.
For information, call me, Bill Creekbaum, CFP at 689-8720 or e-mail me at William.a.Creekbaum@rssmb.com
