If May brought the hint of rain in the air over the stock market with its relentless slow grind downward, then June has gathered the big storm clouds. Damage to market confidence that began with the Enron collapse and the renewed implosion of dotcom and telecom stocks has now become mired in revelations of outright fraud in corporate reporting and leadership. Tyco's CEO has left in disgrace, Martha Stewart is struggling to explain away apparent insider trading in ImClone stock, and now WorldCom admits to $3.8 billion in inflated earnings over the last five quarters! No wonder stockholders are voting with their feet until the clouds overhanging Wall Street clear.
And the clouds leave no holes for blue sky. Every major sector has fallen in June. What had been rotation among sectors has coalesced into a broad, accelerating downtrend on the major averages. Even the resurging Japanese market (see Nikkei chart below), bolstered by a stronger yen and the promise of a long-sought recovery, has slipped and fallen down the same slope that marks the Dow, Nasdaq, and other indices.
During such steep declines, spiking volatility indices have typically provided assurance that a reversal is soon to come. Yet, while the VIX--the S&P 500 Volatility Index--has moved up rapidly of late (see chart below), it still pales to the parabolic spike of the days that followed 9/11. Moreover, while the Nasdaq is once again near the 1,400 low that was set after 9/11, the Dow sits over 1,000 points above its September low (both charts below). More downside may very well be ahead.
No market is without any ray of hope, however. While the dollar continues to fall against other world currencies, its nemesis--gold--may have peaked in its year-plus rally (see chart below). When the ultimate hedge against recession quits rising, one must question whether recovery may indeed be at hand. The market does turn decisively, after all, about six to nine months before the actual recovery in the economy.
Other hints of clearing clouds can be found in manufacturing, too. Production numbers have begun rising again, after a long, long decline. Sustainable uptrends in the cyclicals that define the manufacturing sector still appear to be some time away, but air pockets of strength have begun to bubble up through the stock market.
Housing remains pretty strong, still, although top-line revenue figures have cooled, suggesting that rising earnings may soon moderate, too, and take their elevated stock prices with them. The advance/decline line of NYSE-listed stocks has been moving upward for several months, showing that the ratio of stocks going up each day compared to the number going down is steadily rising.
Add in the bouyancy of real estate investment trusts through the summer decline and a new theme begins to emerge. Perhaps the broad market decline is part of a long-term reallocation of assets from stocks into real estate, whether through increasing investments in homeownership or through stakes in REITs. If true, the real estate and housing market may offer our next boom opportunity, even after two years of impressive gains. With inflation in check, the Federal Reserve likely to leave rates low for some time, and mortgage rates remaining historically low, housing and real estate may be propelled upward in value. This established trend has been under attack by market pundits for months. The big news would be if earnings of homebuilders and developers continue to rise, recasting the current picture of an economy running out of gas into one with high hopes in the real estate market.
One final thought is worth pondering before all hope is lost with the market. From these accelerating selloffs, like the one of June, is the opportunity to use precious cash to open new stock positions at bargain prices, then watch them rise in the updraft that follows a "capitulation" selloff. The trick is to stay in cash through the bottom, rather than grasping at "falling knife" stocks. Regardless of perceived underlying quality, even the biggest stocks--think Enron and WorldCom--offer no assurance against capitulation that continues all the way to zero.
Cash is king today. Until market volatility turns down and prices across the market turn up, cash's reign is secure. Now are the days to ponder what could go "right," though, and prepare to pounce on the many really great stocks that will blast upward, once market confidence returns. For every WorldCom, there is an AT&T; for every Enron, an ExxonMobil; for every Tyco, a GE; and for every Gateway, a Dell. Or so it appears today.
With every blowup, some likely winners are getting hurt, too. Their superior businesses and clean accounting will win out. Not to mention the lack of overly aggressive and dishonest chief competitors! Today's forecast calls for rain, but the days of sunshine will come again.
