Archive for Sunday, June 23, 2002

Stock market reflects worries about future

June 23, 2002

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If the recession is over, why are stocks doing so poorly?

Of course, we're assuming the recession is over. Most experts seem to think it ended in December, though the official judges at the National Bureau of Economic Research have yet to rule.

At any rate, stocks certainly aren't signaling that happy times are back.

The Standard & Poor's 500 is down 11.7 percent this year, while the Dow and Nasdaq are off 4.7 percent and 23 percent, respectively.

"It is definitely the worst performance since World War II, coming out of a recession," says Wharton finance professor Jeremy Siegel, author of the well-known book "Stocks for the Long Run."

Many experts say the stock market tends to rebound about six months before the end of a recession, as investors jump into stocks to share in the stronger corporate earnings they expect to come.

Investors did that this time except that they overdid it, Siegel said.

From the start of the recession in March 2001 through Sept. 21, 10 days after the terrorist attacks, the S&P 500 lost 22 percent. From then until the end of 2001, it soared 19 percent, as investors began to anticipate an end to the recession.

But this year, Siegel said, investors have realized that corporate earnings, the foundation of stock prices, are not going to return to the 10, 15 and 20 percent growth rates people had come to expect in the 1990s.

Indeed, economic reports last week showed retail sales slumping and consumer sentiment souring. Consumers' continuing willingness to spend money has been a mainstay of the economy, and it's worrisome to see cracks in that foundation.

Many experts had expected the nation's gross national product the broadest measure of the economy to grow slowly in the first half of this year, and to accelerate in the second half. Now, Siegel said, economic statistics suggest the recovery will proceed more slowly than that.

"You can't have earnings gains in the double digits when sales are going up in the single digits," he said. Hence, investors realize that the run-up in stock prices at the end of last year was excessive; now they're pulling back.

In addition, investors realize that stock prices have yet to fall to bargain levels, despite the slump of the past two years. The ratio between share prices and corporate earnings for the past 12 months is in excess of 41.32-1 for S&P 500 stocks, for example. That's below the nearly 50-1 at the height of the stock bubble in 1999 and early 2000. But it's still very high the historical average is about 15-1.

Earnings would have to soar to justify such high prices.

Stock ownership is a bet on earnings growth, and it has always been difficult to accurately forecast what earnings will be. Now, however, the situation is even more difficult because investors aren't even convinced they know what earnings have been in the past a figure that is supposed to be solid.

The scandals that began with Enron and Arthur Andersen and spread to a number of other large corporations have put a cloud over earnings reports.

It's not simply a question of wondering if some companies have cooked the books. Today, the experts can't even agree on how earnings should be calculated. Should the cost of employee stock options be subtracted? What about debts held by subsidiaries and partnerships?

In recent years, many companies have taken to emphasizing "operating earnings," which tend to boost earnings by eliminating expenses included in the standard earnings reports required by the Securities and Exchange Commission.

"Earnings are a mess," Siegel said.

Finally, a number of global factors are making investors jittery.

A stock investment is a bet on the future, and right now the future looks troubling. So stocks are struggling, even though most experts think the recession ended six months ago.

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