Amid market slide, room for hope
The US stock market has lost more than 11 percent since the end of April, measured by the Standard & Poor’s 500 index. That puts the market in an official “correction.’’ More and more signs point to weakening economy and possible recession. Could this be the start of another bear market? John Dorfman, chairman of Thunderstorm Capital LLC, a money-management firm in Boston, answers some questions that worried investors have on their minds.
Q. Is this the start of a new bear market?
A. There have been 93 corrections of 10 percent or more since the beginning of 1928, according to Ned Davis Research Inc. In 25 cases, those downturns developed into full-fledged bear markets, defined as a decline of 20 percent or more. So the historical odds suggest the chance of the present correction turning into a bear market are 27 percent. It would be unusual for a bear market to start when corporate earnings are healthy and interest rates low - but not impossible.
Q. Does the turmoil in stocks and bonds mean another recession is around the corner?
A. Not necessarily. One good indicator of upcoming recessions is the US leading index disseminated by the Conference Board, a business research group. That index has pointed up in 16 of the past 18 months, including May and June. The July figure isn’t out yet. Meanwhile, the Labor Department’s latest figures show payrolls grew by 117,000 workers in July. The unemployment rate dropped in July to 9.1 percent from 9.2 percent, and corporate profits still look robust. The US economy has expanded for eight consecutive quarters, but growth in the past two quarters was feeble.
Q. Why didn’t the budget settlement make the stock market perk up?
A. One reason is the settlement barely makes a dent in the US budget deficit. The two parties agreed to cut government spending by $2.5 trillion over 10 years, with most of the cuts still to be determined. That works out to about $250 billion per year, which is less than one quarter of the projected budget deficit of $1.1 trillion for fiscal 2012. Under the Obama administration’s proposed budget for fiscal 2012, the country would spend $3.7 trillion, while taking in $2.6 trillion of tax revenue.
Another reason investors disliked the budget deal was the ugly way it was reached, with a crisis atmosphere and little evidence of bipartisan cooperation.
While the budget compromise removed the immediate threat of a downgrade in America’s credit rating, the leading credit agencies, Moody’s and Standard & Poor’s, could still do such a downgrade before the year is out.
Q. Are today’s problems worse than those of the 2007-2008 financial crisis?
A. The problems in 2007-2008 were probably worse. Major financial institutions then were in imminent danger of bankruptcy, and some did go bankrupt. Lehman Brothers failed. American International Group, General Motors, and Fannie Mae were taken over by the federal government, which still owns significant shares of these companies. In 2007 and 2008, the US leading index was down 18 months out of 24. Many corporations and individuals were operating far out on a limb with heavy borrowing. Today, corporations have improved their balance sheets considerably, and some individuals have done the same. Perhaps the scariest heavy borrowing today is that of federal and state governments.
Q. What reason is there to invest in stocks now?
A. There are many reasons. Corporate profits are strong this year, and realistically that is usually the first step toward a durable economic recovery. Merger and acquisition activity has picked up, another good sign. Stocks, which in 2000 sold for more than 30 times earnings, now sell for 13 times recent earnings and 12 times estimated 2011 earnings. Those ratios are cheaper than average. Interest rates are low, and inflation - though it may become a threat - is not one now.
The earthquake, tsunami, and nuclear meltdown in Japan slowed economic growth worldwide in the second quarter. Now, the rebuilding effort should be a plus for worldwide growth in the remainder of the year.
There is truth in the old Wall Street adage that the market climbs a “wall of worry.’’ Today’s crisis tends to become tomorrow’s routine problem. Then investors find new worries to preoccupy them.