Signs of Bear’s Rout Renew Stock Questions

Some people who swore they’d never again be interested in the stock market, after the losses of the last three years, lately may be finding it difficult to resist sneaking a peek.

The rally in share prices since Oct. 9 has carried the Dow industrials up 22.1%, to 8,896.09 as of Friday. The Nasdaq composite is up 32.7% in the same period.

The Standard & Poor’s 500, the index to which hundreds of billions of dollars of investor wealth are directly tied, has risen 20.5% and is approaching a potentially critical point: If the current rally carries the S&P; up at least 21.5% from its lows, it would be the strongest advance the index has mustered since the bear market began in 2000.

A gain of 20% in the S&P; also has been the threshold, historically, at which the market is said to be in a new bull phase.

For many investors, these statistics will elicit only scowls. After the longest and deepest market decline since the late 1930s and a full year’s worth of corporate scandals and revelations of deceitful brokerage practices, most Americans almost certainly maintain a healthy skepticism toward Wall Street. It would be news only if they didn’t.

Still, December usually is a good month for stocks. If this month follows suit, it will force more investors to ask some questions that seemed far afield just a couple months ago:

What if the bear market really has ended, after 2 1/2 years?

What if your retirement account has stopped going down?

What if you could reasonably expect to earn 700% more in stocks in 2003 than in a money market fund?

The latter isn’t a math trick. If stocks rise just 8% next year and money fund returns stay at 1% or less, the market will beat cash accounts sevenfold.

Reading a Rebound

To be sure, there are many institutional and individual investors who believe that the current rebound in stocks is just another brief bear-market rally, to be followed soon by another steep decline in share prices.

The argument that the bear remains large and in charge is well-enough supported. The global economy is rickety, and if it falls apart in 2003 equity markets worldwide probably would fall with it.

What could sink the economy? The terrorists still are out there and could be plotting another devastating attack. And a war between the United States and Iraq still is a strong possibility, if not probability.

Even if the economy’s pace improves, bolstering corporate earnings, many stocks already are fairly priced or high-priced relative to expected 2003 profit, market skeptics say.

General Electric shares, for example, have risen 23% since Oct. 9. At $27.12 on Friday, the stock was priced at 16.5 times the $1.64 a share that analysts, on average, expect GE to earn in 2003, according to Thomson First Call in Boston.

That’s a far lower price-to-earnings ratio than GE commanded in the boom years of the late 1990s but it’s slightly above the stock’s average P/E of the early ‘90s, when investors arguably had a more rational view of the world and what could go wrong.

The case for lower stock prices has held sway for 2 1/2 years, a very long time by U.S. bear market standards. That has brought the bear camp many more converts. But it also is one of the best arguments for why the market may finally have bottomed: These periods don’t last forever, Japan’s 12-year experience notwithstanding.

Wall Street’s rally since early October has been rooted in a growing assumption that the U.S. economy will be at least OK in 2003 and that the surprises with regard to corporate earnings could be more positive than negative. A number of reports last week, including data on consumer spending and factory orders for big-ticket items, provided more evidence that the picture is improving.

With that backdrop, the natural inclination of many professional investors is to buy stocks, because that’s the fastest way to make a bet on economic growth.

“For the first time in a long time, I’ve become very optimistic about the market,� said John Rogers Jr., a value-oriented investor whose Ariel Capital Management in Chicago manages more than $10 billion.

“I think expectations got to be way too low.�

Meanwhile, other factors that contributed to the severity of the bear market -- which drove the S&P; 500 down 49% from its 2000 peak to its Oct. 9 low and the Nasdaq index down 78% in the same period -- are receding. Corporate accounting scandals are old hat. And nobody’s surprised anymore that brokerages have routinely been less than trustworthy in their advice.

Basic Questions

Let’s say the bulls are right, and the market decline overall has run its course. Individual investors are likely to be asking themselves one of two basic questions, or maybe both:

* Should I buy? Just because the market is rising doesn’t necessarily mean it needs more of your capital. Patient investors who have stuck with equities through the bear market may already have all they need; now it’s just a matter of watching the stocks rebound if the rally can be sustained.

It’s also critical that investors be realistic about the returns the market can produce over the next few years, financial advisors say. Patience might become even more important if the best average return stocks can generate is, say, 6% to 8% a year.

On the other hand, returns in that range still might far exceed what will be available from other financial assets, such as Treasury bonds and short-term cash accounts. Remember: When the economy is expanding, investors typically look to stocks first.

If your time horizon truly is long term, “You really need to consider taking on some risk to get a higher return now,� said John Hollyer, who helps manage the Vanguard Prime Money Market Fund, which offers investors a yield of just 1.37%.

Unless you’re a trader, however, be wary of getting sucked into wild gains in individual shares, many veteran investors caution. “Momentum� investing -- buying by portfolio managers who are simply trying to ride the fastest-moving shares they can find -- is alive and well, particularly in the technology sector. Often, the faster a stock rises, the greater the risk that it could quickly reverse.

* Should I sell? Why sell into a rising stock market? If you believe that the economic outlook is far grimmer than the market now assumes, a rebound in share prices gives you an opportunity to exit either at a profit or with a smaller loss.

Selling also might be warranted if you’re looking to shift assets from one stock market sector to another that appears more promising.

In particular, investors who are benefiting from the snap-back in many technology shares might ask whether they should use the rally to pull money out of those stocks in favor of diversifying into other industry groups.

At some point, another reason to sell stocks may be to fix your long-term asset allocation among stocks and bonds: If you’ve wanted to own Treasury securities, for example, but have been reluctant to buy them this year as yields plunged, a continuing surge in yields could give you an opportunity to lock in better risk-free returns for the long term.

An asset allocation plan should be the driving force behind all buy and sell decisions, Hollyer said. If you have a plan that assures your portfolio always is well diversified and reflects your risk tolerance, then the only issue is having the discipline to stick with the program and make automatic asset shifts accordingly.

In the long run, that is a lot easier, and less stressful, than trying to predict the future of financial markets.

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Tom Petruno can be reached at [email protected]. For recent columns on the Web, go to: www.latimes.com/petruno.