More Pessimists Are Bearing Down

After last week’s stock market carnage--and the potential for much more this week--the ranks of confirmed Wall Street bears are growing.

The feeling that stocks have just been in a “correction� this year, after a three-year bull market run, is giving way to resignation that a genuine grizzly is bearing down--one that could slash 20% or more from the average stock, measured from this year’s peak prices.

“We think we have moved into a bear market,� said Andy Engel, senior research analyst at the Leuthold Group, a Minneapolis investment advisory firm.

“We probably are in a bear market,� conceded Jim Crabbe, a veteran money manager at mutual fund firm Crabbe Huson Group in Portland, Ore.

On Friday, the Dow Jones industrials tumbled 62.15 points to 3,636.94, the biggest one-day decline since March 30--when the market was in the midst of its first major downdraft related to the sinking dollar and surging bond yields.

Even as the dollar recovered and bond yields eased earlier this month, the Dow failed to rebound within easy striking distance of its record high of 3,978.36 reached on Jan. 31.

From the spring low of 3,593.35 on April 4, the Dow crested at 3,814.83 on June 14--before breaking down again, as the dollar’s slide resumed and bond yields jumped.

In this latest stock decline, the broad market has fared much worse than the blue-chip Dow. The Nasdaq composite index of mostly smaller stocks closed at a 12-month low of 693.79 on Friday, down 4.9% for the week. That extended the drop from its all-time high to 13.7% so far.

Bearish analysts say Wall Street’s slow downward grind could accelerate this week, as the deteriorating market and political backdrops converge with normal end-of-quarter pressures to drive more gloomy investors out of stocks.

Among the problems the market faces this week:

* The dollar’s dive below 100 Japanese yen early today in the Far East may herald a battle royal between currency speculators and the world’s central banks, most of which attempted to support the dollar Friday, with only mixed results.

Every decline in the dollar raises the odds that foreign owners of U.S. stocks and bonds will dump more of their U.S. holdings, because the dollar’s weakness automatically devalues their portfolios.

* Growing expectations of another hike in short-term interest rates by the Federal Reserve Board--to defend the dollar--could spark heavy selling of stocks by investors who had believed the Fed was finished tightening credit at least until fall.

The Fed’s policy-making committee will meet July 5, immediately after the three-day weekend for the Independence Day holiday. Thus, investors who are unwilling to carry stocks over the long weekend, fearing a Fed rate boost, may feel compelled to sell this week.

* A slew of political setbacks worldwide in recent days has raised new questions about global leadership--or the lack thereof--as the world economy attempts to escape the last vestiges of the early-’90s recession.

In Japan, the fledgling government of Prime Minister Tsutomu Hata resigned on Saturday rather than face a no-confidence vote.

In the United States, the dollar’s slump has sparked fresh criticism of President Bill Clinton’s policies. In Europe, the European Union was unable to reach agreement over the weekend on a successor to outgoing European Commission President Jacques Delors.

And in Mexico, Interior Minister Jorge Carpizo, who is responsible for overseeing the presidential election on Aug. 21, abruptly resigned on Friday, only to rescind his decision on Sunday.

* Finally, the second quarter’s end on Thursday means some portfolio managers will as usual be eager to do some “window dressing� this week, cleaning dogs out of their portfolios and perhaps raising cash levels (and lowering their overall exposure to stocks) to show clients a more cautious approach on second-quarter statements.

Of course, with so much working against the market, some Wall Streeters believe that the smarter approach today isn’t to bet with the bears, but to take a contrarian view--the idea being that the market will always do its best to confound the majority’s outlook.

Michael Burke, whose New Rochelle, N.Y.-based Investors Intelligence service tracks bull and bear sentiment weekly among 135 market newsletter writers, admits that the percentage of bullish newsletters, now 27.2%, is near its lowest reading since 1988.

But Burke believes the gloom has become so overdone that “we’re getting close to a bottom in the market.� While the bears point to sinking indexes like the Dow and the Nasdaq composite, Burke notes that “a lot of stocks are holding well above their April lows,� which he views as a sign of a market getting ready to turn.

But many pros warn that contrarianism, when applied to the broad market, can become a trap during a true bear phase. The fact that most people are bearish doesn’t necessarily mean that all or most of them have yet sold any stock, after the long bull market. It’s the gradual capitulation of those “fully invested bears� that can drive the market painfully lower as bad news take its toll on investor psychology.

If the bear is here, exactly what kind of bear will it be? Here’s how some experts see it:

* Jeffrey Applegate, strategist at brokerage CS First Boston in New York, views this as an interest-rate-induced bear market that doesn’t reflect anything fundamentally wrong with the economy or with corporate profits.

The market, Applegate says, is merely learning to live with higher interest rates and a stronger economy, but that’s enough of a shock (after five years of falling rates) to cause a bear phase, he says.

He sees the bottom for the Dow industrials at around 3,400, which would be about a 15% decline--traditionally, the minimum drop required to be called a bear market.

Given the relatively mild further losses that he expects, Applegate questions whether many investors should bother to sell out of stocks on the expectation of buying back later, at lower prices. The reality, he says, is that many investors will find it extremely difficult to nail the timing on this one.

* Crabbe, of Crabbe Huson, expects a market so volatile that “it’s going to be hard to recognize it (as a bear) day to day.� He believes the Dow could even rebound to its 1994 peak later this year, but that “we’d still be in a bear market.�

Ultimately, he expects the average stock to lose 25% of its value, from peak levels, before this decline runs its course. That means a Dow of about 3,000 at the bottom.

But because of the volatility he foresees, Crabbe believes this market will be ideal for stock pickers who know how to trade. He likens it to the late-1970s--a terrible period for buy-and-hold investors, but a great time for nimble opportunists, he says.

Two depressed stocks he has been buying: Apple Computer ($25.61 on Nasdaq), and spinal-implant maker Sofamor/Danek ($12.25 on NYSE).

* Andrew Addison, who writes the Addison Report market newsletter from Franklin, Mass., surmises that the bear market is already about eight months old, and expects this to be a “traditional� one--meaning it could last 12 to 18 months in all, he says.

He sees the Dow eventually bottoming at 3,200 to 3,400. “It’ll be painful, but typical,� he says, and not the horrific meltdown that some mega-bears predict.

Investors who aren’t willing to try and time the market may just want to consider buying some hedges to help their portfolio, Addison says. He thinks gold stocks and energy-service stocks, for example, will gain even as the broad market sinks.

Tax Issues If You Sell a Fund

Bear-market-fearing mutual fund investors who decide to sell part or all of their fund holdings should think in advance about tax ramifications. The Internal Revenue Service requires that you pick one of four accounting methods to calculate gains or losses on fund shares you sell, and each method can result in different tax consequences. Moreover, once you select an accounting method for a particular fund, you must use that method for all subsequent sales of that fund. The four methods:

* First in, first out (FIFO). This method assumes you sell shares in the order they were purchased, thus recording gains or losses based on specific prices you paid for each share. Obviously, this can be cumbersome (especially if you’re reinvesting dividends regularly in new shares). But if you don’t specify another accounting method when you sell, the IRS will assume you’re using this one.

* Specific identification. If you’re selling only part of your fund holdings, you can specify (to the fund company) exactly which shares you want sold, thereby managing the size of the gain or loss realized. But like FIFO, this method requires diligent record-keeping on your part.

* Average cost, single category. The easiest accounting method, and one that some fund companies will figure for you. Under this method, the total purchase cost of all shares in your account is divided by the number of shares held, giving you a single average cost basis per share, which you then use to figure the gain or loss on shares sold. The holding period (short-term or long-term) for each share sold is based on FIFO.

* Average cost, double category. Same as above, except you figure two average per-share costs: One for shares held long-term (longer than one year) and one for shares held short-term (one year or less). This is useful if you have been an active buyer over the past year, and want to separate long-term gains or losses from short-term ones, for tax purposes. (Remember, long-term gains are taxed at a lower rate than short-term gains.)