Stock Market Outlook: Bad to Worse

NEW YORK — The equity markets are braced for a tough 2003, regardless of what happens in Middle Eastern deserts or South American oil fields.<br><br>At the forefront, of course, are concerns over the possibility of war with Iraq, followed by...

NEW YORK — The equity markets are braced for a tough 2003, regardless of what happens in Middle Eastern deserts or South American oil fields.

This story first appeared in the March 17, 2003 issue of WWD.  Subscribe Today.

At the forefront, of course, are concerns over the possibility of war with Iraq, followed by concerns about North Korea. Other geopolitical issues, such as Venezuela, have added to the run-up in energy costs, which in turn has depressed consumer spending on discretionary items. As reported, Salomon Smith Barney estimates that a 1 cent increase in the price of gasoline translates into a $1 billion decrease in retail spending.

Consumers already have indicated that they’re feeling the heat, or at least the cost of purchasing it, during this cold, frightening winter. Last month’s Consumer Confidence Index, provided by The Conference Board, was the lowest in 10 years, dropping 14.8 points to a lower-than-expected 64, the worst showing since October 1993’s 60.5 mark. This performance suggests continued pressure on retailers, already deprived of top-line growth by a lackluster holiday season and a winter stormy enough to keep weekend shoppers away from the malls.

Even when the weather improves in colder regions of the U.S., consumer attitudes might not: The Expectations component of the confidence index fell 15.5 points to 65.6 in February.

The Conference Board noted earlier this month that consumer confidence has tumbled in all nine regions of the country, with the Rocky Mountain and East North Central regions showing the biggest declines in February. Lynn Franco, director at the Conference Board, said in a statement, “Job worries, rising energy costs and war fears have lowered confidence from the East Coast to the West Coast and in all areas in between.” The board noted that job opportunities across America, measured by the Help-Wanted Index, have also dwindled.

Richard Hastings, chief economist for Cyber Business Credit, said, “The economy is headed down. We are marching toward a bad intersection. The problems, however, have little to do with Iraq. All of the problems were in place prior to [the] Sept. 11 [terrorist attacks].”

According to Hastings, the lingering downturn since the March 2000 dot-com bubble burst is an indication of a secular bear market. Secular bears, which occur once every 100 years, correct the excesses left over from major bull markets. Hastings is concerned about this one.

“A secular bear market can last through a decade,” he said. “The last one we had was between 1929 and 1948. We are talking about big cycles. The last secular bull market lasted from 1982 to 2000. The longer the bull run, the bigger the overhang and the greater the excess. We have in place factors suggesting a long downturn.”

Hastings is keeping tabs on five key areas to help determine what could happen next: rising government deficits; higher prices for oil and other commodities; an increase in the debt overhang; growing unemployment levels, and the declining dollar.

Louise Yamada, Salomon Smith Barney’s technical strategist, has been focusing on the highs and lows of the different stock market indices.

The Dow Jones Industrial Average plummeted in October 2002 to 7,286, but bounced back and was trading over the 8,800 mark as recently as January. In the first week of March alone, however, the Dow has been steadily falling from 7,837 to the 7,650 range. The Dow is still on a see-saw. Last Monday, the Dow celebrated the three-year anniversary of the bursting of the technology bubble by plunging 171.85 points to close at 7,568.18. The Dow on Thursday surged 269.68 points to close at 7,821.75 as investors perceived a long or immediate war in Iraq as being less likely, even though reports on retail sales were worse than expected, and unemployment figures were still rising.

Both the Nasdaq Composite and the Standard & Poor’s 500 have been holding their own in the past six weeks at the 1,300 and the 800-plus ranges, respectively. On Friday, the Dow advanced another 37.96 points, or 0.5 percent, to finish the day at 7,859.71.

Yamada’s recently issued war study observed that the “continued deterioration in the technical underpinnings of the equity market” carries a high probability that the October lows — Dow at 7,286, Nasdaq at 1,114 and S&P at 776 — may be tested. She wrote that a failure of the indices to hold their lows would suggest new lower levels: the Dow at 6,500 and the S&P at 700. How low the Nasdaq might fall would depend on bellwether components, such as Microsoft. She didn’t rule out the Nasdaq dropping to 1,000 or even the 800 range.

More importantly, she wrote, are the established trends in the equity market, which determine the effect of the outbreak of a possible war on the direction of the market. The onset of conflicts in Korea, Vietnam and Kuwait occurred during a bull market, and at worst created a temporary setback.

According to Yamada: “If the dominant trend of the market was down [as in the case when World War I broke out in 1914] or in the process of a top [as in 1939 or later in the Vietnam War], the outbreak [or, in the case of Vietnam, the intensification] of war can precipitate or continue the market’s declining trend.” She concluded that because the market is in the early stage of a structural downturn, the technical observation suggests that an outbreak of war carries the risk that the equity markets could fall to new lows.

Henry G. Van der Eb, portfolio manager for The Gabelli Mathers Fund, wrote in his yearend report to shareholders that when bubbles burst, prices historically decline below the point of the initial advance, which he pegged in December 1994. “This implies the Dow at 3,500, the S&P 500 at 425 and the Nasdaq Composite at 700,” he concluded.

Perennial bear David W. Tice, portfolio manager for the Prudent Bear Funds, in his quarterly letter to shareholders observed that the stock market is not close to a new bull cycle because stocks are still overvalued and there is no indication of investor capitulation. In addition, we are still in the early stages of a liquidation of mutual fund holdings.

“History tells us that once these outflows start in earnest, they can last for a long time. The cumulative outflows so far have been very brief, and are only a very small fraction of the prior inflows,” he wrote.

Even worse, continued booming consumer borrowing and spending is barely keeping the “maladjusted economy afloat. Today, the consumer is waterlogged and exhausted. The consumption-based economy looks weathered and frail,” the fund manager concluded.

A Jan. 29 market indicator report from Salomon Smith Barney referred to a slightly less scientific method for predicting market direction. It said that when a team originally in the National Football League wins the Super Bowl, the Dow finishes up for the year. The opposite occurs when a team originally in the American Football League wins. Since 1967, the sports litmus test has been correct 30 out of 36 times. The Tampa Bay Buccaneers’ victory this year suggests an “up” finish.

Carl Steidtmann, chief global economist at Deloitte Research, observed that there’s still a lot of money on the sidelines, with consumers still willing to open their purse strings at retail.

According to the February’s Deloitte Research Leading Index of Consumer Spending, growth in consumer expenditures will slow to a 6.2 percent annual rate in the months ahead. The anticipated slowdown in growth reflects a rebound in the U.S. savings rate, which climbed to 4.3 percent in the fourth quarter of 2002, from a record low of just 0.8 percent of income in the same 2001 quarter.

“With cash from the past year’s reduction in their tax burden, real-income growth and home mortgage refinancing, consumers are in a position to continue spending,” Steidtmann said.

For many companies, he noted, success will depend on their ability to increase market share.

Nick Jones, portfolio manager at investment advisory firm Ashland Management, said that he expects to see corporate earnings improve steadily. Jones doesn’t foresee a major drop in the market should a war break out, noting that there is probably already a war discount built into the prices.

The outlook for apparel and retail sales, however, is less promising, whatever happens on the diplomatic or military fronts. Noelle Grainger, apparel analyst at J.P. Morgan, wrote in a research note: “It seems unlikely that apparel and footwear companies will have much success accelerating core U.S. sales growth unless consumption picks up in 2003. Acquisitions should help some companies outpace our forecast for 2 percent to 4 percent consumption gains.”

Brian Tunick, specialty retail analyst at J.P. Morgan, observed in the same report: “We note that apparel and footwear spending trailed off significantly heading into the beginning of the Gulf War in 1991, and remained quite volatile through the next year….Even if a potential conflict ends quickly, we think a host of other problems will weigh on consumer confidence, including the weak economy and job market, the worry about North Korea’s nuclear threat and the risk of additional terrorist attacks.”