Barrons - Shock And Awe - Next Time You Better Beleive The Cassandras

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Monday, October 13, 2008

UP AND DOWN WALL STREET

Shock and Awe By ALAN ABELSON

A stock-market week that will live in infamy. Next time, you better believe Cassandra. HOW DO YOU SAY "MASSACRE" IN AT LEAST A DOZEN LANGUAGES? A little more urgent perhaps: Do you happen to know the best place to view the end of the world? We watched last week -- and for some reason we suspect we were not alone -- with no little awe and plenty of shock as the stock market all but disappeared into the greatest sinkhole in all of investment history. The Dow Jones Industrials lost 18% over five trading sessions that swelled their loss for the past 12 months to 40%. The S&P 500 also was off 18% for the week, 43% for the 12 months. Not to be left behind, Nasdaq lost 15% for the week and 42% since October 2007. In this race to the bottom, leading foreign markets were nothing if not competitive, while emerging markets magically became submerging markets. China and Russia are neck and neck for the rusty tin medal, each off by over 60% so far in this memorable market year. A number of far-away bourses decided the best way of stopping the free-fall in prices was to shut down and desperately seek some form of artificial resuscitation. To try to thaw the stubbornly frozen credit markets, the chiefs of what purport to be the major economic powers, including our own blessed nation, held a quickie powwow and took a cut out of interest rates and hurled hundreds of billions more at needy or dissolute banks and kindred institutions around the world. The effort was herculean; too bad the effect wasn't. As the tumultuous week drew to a close, hopes that economic shamans from the far corners of the planet -scheduled to meet in confabs on Saturday and Sunday -- would concoct a cure for the financial ills that have befallen it encouraged a gentler Friday close in our markets. Or, it could be just that the sellers got plumb worn out and badly needed a rest. DOW JONES REPRINTS This copy is for your personal, non-commercial use only. To order presentation-ready copies for distribution to your colleagues, clients or customers, use the Order Reprints tool at the bottom of any article or visit: www.djreprints.com. • See a sample reprint in PDF format • Order a reprint of this article now.

It wouldn't knock our socks off if somewhere in here the market actually showed it can go up, at least for more than a session. Stocks tend to rally even in the ugliest bear markets, and this certainly is in that category. But it also, as many a technician has learned to his rue, thinks history is bunk and tramples all over precedent. We'll see.

10/11/2008 6:50 PM

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The truism we fervently hope investors, big and small, amateur and pro, take away from their brush with the stillsmoldering inferno that has consumed over $8 trillion of their hard-earned money is there are times when the worst advice you can possibly heed is the admonition, "Don't panic." WE'VE ALWAYS HAD A THING FOR CASSANDRA, the ancient Trojan princess who was blessed with the gift of prophecy and burdened by the curse that prevented anyone from ever believing her. Just shows you how capricious those old Greek gods were -- prone, just for the sport of it, to handing out favors with their right hand while snatching them away with their left. Of course, if she was the betting type -- and antiquity is silent on that score -- she might have drawn consolation from wagering on the Olympics and the odd marathon, after a quick peek into the future to catch the winner. But our hunch is that it couldn't but profoundly grieve spunky Cassandra to be right as rain in predicting everything from the weather to the outcome of wars -- and not getting so much as the faintest whiff of respect for her fabulous forecasts. Still, one admirably tough cookie, she refused to be daunted and kept those terrific prognostications coming. And she did it effortlessly, without crystal balls or any other of the hocus-pocus paraphernalia. What got us ruminating this way was the rude tendency of the low-rent crowd in the Street to dis that relative handful of foresightful folks who saw the bear market coming -- and we don't mean saw it yesterday or the day before. They may not be in Cassandra's league -- how could they be, after all? She's mythical and they're human and hence fallible. But they deserve a big hurrah, especially since so many of Wall Street's wise guys who've been buried by the market collapse can't forgive them for being right. So, if for no other reason than to please dear old Cassandra, wherever she is, we'd like to tip our hat to a couple of her latter-day spiritual heirs who don't get a heck of a lot of public notice, and when they do it's usually accompanied by a sneer. One of these stalwart seers is Albert Edwards, of Société Générale. Albert has been predicting an investment "Ice Age" for what seems like an ice age, complete with a brutal recession and a stock market collapse to match. In early September, he sounded the alarm on an imminent "meltdown" of the economy and the equity markets (there's an obvious meterological dissonance in a meltdown occurring in an Ice Age, but this is no time to be picky about incompatible metaphors). Albert's own forebodings so unnerved him that he chose to surrender contented bachelorhood for marital bliss. When he isn't spreading gloom and doom or becoming a groom, he writes a sprightly and incisive global market and economic commentary. In his latest epistle, he confesses to having been tempted to recommend a bit of buying in expectation of a bounce, but then wisely resisted the temptation because of the increasingly grim economic and profits data. He doesn't rule out the possibility of a sharp bear-market rally of perhaps as much as 22%, but that would be merely an interruption of the inexorable downtrend that he believes will carry stocks down 70% from their peaks. That means, if he's right, we're not all that much more than halfway through the misery. Like Albert, Fred Hickey, feisty proprietor of the High-Tech Strategist and valued member of Barron's Roundtable, has been resolutely bearish for quite a spell on the economy, on his special investment turf -- the techs -- and on the market as a whole. Fred's a tough hombre, and he has shrugged off his share of ragging by the abundant population of loud louts during that late and unlamented stretch when euphoria gripped Wall Street and spilled over into Main Street. Rather than brood, Fred turned his unyielding negative stance to good use by buying puts and selling them, for the most part propitiously, all the while adding to his gold stake. Inevitably, Fred was much too early in his downbeat assessment of stocks like Research in Motion and Apple, and it cost him; but he doughtily kept both in his cross-hairs

10/11/2008 6:50 PM

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and has reaped the handsome rewards when the two erstwhile highfliers went down like a stone in this year's cataclysmic crash. We chatted with Fred late last week, and he was resolute that we were on a collision course with a classic capitulation that might see a four-digit drop in the Dow -- which came perilously close on Thursday -- that would likely create a short-term market bottom that could hold at least for a few months. As we spoke, and before the market turned tail and went completely over the edge, he admitted drawing a measure of comfort from his puts on, among other stocks, Amazon.com (ticker: AMZN), which he had described in his recent letter as "a retailer with a 50 P/E heading into the worst economic slowdown in decades," and whose two biggest markets are the U.S. and the U.K., with heavy exposure to Europe, all of which are struggling to cope with dangerously foundering economies. The weakness in the euro and the pound, moreover, could take a painful bite out of Amazon's earnings. He's also down on Qualcomm (QCOM), whose customers are suppliers to the big wireless outfits, which, heavily laden with inventories, reportedly are asking for a slowdown in shipments. He suspects the company's guidance on operating results are at risk. An institutional favorite, Qualcomm shares could be ripe to become a target for a spate of aggressive selling. Fred remains skeptical about the outlook for techs generally. He sees the sector as immediately vulnerable to a blizzard of lowered earnings estimates in the weeks ahead. And what impressed him most about IBM 's (IBM) thirdquarter report, released last week and somehow overlooked by investors starved for a scrap of bullish fare, was that the company missed its revenue target by a bunch, not the most favorable of omens. An old Boy Scout, Fred staunchly believes in being prepared. So he has drawn up a list of what to buy comes the post-capitulation rally. Since he's convinced we're heading into a deep and extended recession, his picks are restricted pretty much to companies boasting high cash flows, clean balance sheets and hefty gross margins. Microsoft (MSFT) is at the top of his list if it can be snared in the low 20s (he bought a little last week). He considers EMC (EMC) attractive in the single digits, reckoning that demand for storage equipment will hold up even in a recession; its software business has been growing rapidly, and it owns most of VMware , No. 1 in virtualization. For that matter, he likes VMware (VMW) itself, plus a bunch of other software companies from Adobe Systems (ADBE), Sybase (SY) and Oracle (ORCL) to Lawson Software (LWSN) and JDA Software (JDAS). He thinks Nokia (NOK) might be worth a look, thanks to its status as the leading mobile phone maker and the stock's 5% dividend. And if you can buy Cisco Systems (CSCO) in the teens, you probably won't be sorry. Why, perhaps a tad giddy, Fred even suggested Apple (AAPL) in the 70s or low 80s might be worth a fling. But mind, he's proposing these as stocks strictly for a rebound, if and when, but not to fall in love with. E-mail comments to [email protected] URL for this article: http://online.barrons.com/article/SB122367870310224535.html

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10/11/2008 6:50 PM

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10/11/2008 6:59 PM

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OCTOBER 11, 2008

What History Tells Us About the Market The breathtakingly volatile week has left investors numb. A close study of the Great Crash, and the decades that followed, offers some unnerving context, and some reasons for optimism. By JASO N ZWEIG

July 9, 1932 was a day Wall Street would never wish to relive. The Dow Jones Industrial Average closed at 41.63, down 91% from its level exactly three years earlier. Total trading volume that day was a meager 235,000 shares. "Brother, Can You Spare a Dime," was one of the top songs of the year. Investors everywhere winced with the pain of recognition at the patter of comedian Eddie Cantor, who sneered that his broker had told him "to buy this stock for my old age. It worked wonderfully. Within a week I was an old man!" The nation was in the grip of what U.S. Treasury Secretary Ogden Mills called "the psychology of fear." Industrial production was down 52% in three years; corporate profits had fallen 49%. "Many businesses are better off than ever," Mr. Cantor wisecracked. "Take red ink, for instance: Who doesn't use it?" Banks had become so illiquid, and depositors so terrified of losing their money, that check-writing ground to a halt. Most transactions that did occur were carried out in cash. Alexander Dana Noyes, financial columnist at the New York Times, had invested in a pool of residential mortgages. He was repeatedly accosted by the ringing of his doorbell; those homeowners who could still keep their mortgages current came to Mr. Noyes to service their debts with payments of cold hard cash. Just eight days before the Dow hit rock-bottom, the brilliant investor Benjamin Graham -- who many years later would become Warren Buffett's personal mentor -- published "Should Rich but Losing Corporations Be Liquidated?" It was the last of a series of three incendiary articles in Forbes magazine in which Graham documented in stark detail the fact that many of America's great corporations were now worth more dead than alive. More than one out of every 12 companies on the New York Stock Exchange, Graham calculated, were selling for less than the value of the cash and marketable securities on their balance sheets. "Banks no longer lend directly to big corporations," he reported, but operating companies were still flush with cash -- many of them so flush that a wealthy investor could theoretically take over, empty out the cash registers and the bank accounts, and own the remaining business for free.

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Graham summarized it this way: "...stocks always sell at unduly low prices after a boom collapses. As the president of the New York Stock Exchange testified, 'in times like these frightened people give the United States of ours away.' Or stated differently, it happens because those with enterprise haven't the money, and those with money haven't the enterprise, to buy stocks when they are cheap." After the epic bashing that stocks have taken in the past few weeks, investors can be forgiven for wondering whether they fell asleep only to emerge in the waking nightmare of July 1932 all over again. The only question worth asking seems to be: How low can it go? Make no mistake about it; the worst-case scenario could indeed take us back to 1932 territory. But the likelihood of that scenario is very much in doubt. Robert Shiller, professor of finance at Yale University and chief economist for MacroMarkets LLC, tracks what he calls the "Graham P/E," a measure of market valuation he adapted from an observation Graham made many years ago. The Graham P/E divides the price of major U.S. stocks by their net earnings averaged over the past 10 years, adjusted for inflation. After this week's bloodbath, the Standard & Poor's 500-stock index is priced at 15 times earnings by the GrahamShiller measure. That is a 25% decline since Sept. 30 alone. The Graham P/E has not been this low since January 1989; the long-term average in Prof. Shiller's database, which goes back to 1881, is 16.3 times earnings. But when the stock market moves away from historical norms, it tends to overshoot. The modern low on the Graham P/E was 6.6 in July and August of 1982, and it has sunk below 10 for several long stretches since World War II -most recently, from 1977 through 1984. It would take a bottom of about 600 on the S&P 500 to take the current Graham P/E down to 10. That's roughly a 30% drop from last week's levels; an equivalent drop would take the Dow below 6000. Could the market really overshoot that far on the downside? "That's a serious possibility, because it's done it before," says Prof. Shiller. "It strikes me that it might go down a lot more" from current levels. In order to trade at a Graham P/E as bad as the 1982 low, the S&P 500 would have to fall to roughly 400, more than a 50% slide from where it is today. A similar drop in the Dow would hit bottom somewhere around 4000. Prof. Shiller is not actually predicting any such thing, of course. "We're dealing with fundamental and profound uncertainties," he says. "We can't quantify anything. I really don't want to make predictions, so this is nothing but an intuition." But Prof. Shiller is hardly a crank. In his book "Irrational Exuberance," published at the very crest of the Internet bubble in early 2000, he forecast the crash of Nasdaq. The second edition of the book, in 2005, insisted (at a time when few other pundits took such a view) that residential real estate was wildly overvalued. The professor's reluctance to make a formal forecast should steer us all away

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from what we cannot possibly know for certain -- the future -- and toward the few things investors can be confident about at this very moment. Strikingly, today's conditions bear quite a close resemblance to what Graham described in the abyss of the Great Depression. Regardless of how much further it might (or might not) drop, the stock market now abounds with so many bargains it's hard to avoid stepping on them. Out of 9,194 stocks tracked by Standard & Poor's Compustat research service, 3,518 are now trading at less than eight times their earnings over the past year -- or at levels less than half the long-term average valuation of the stock market as a whole. Nearly one in 10, or 876 stocks, trade below the value of their per-share holdings of cash -- an even greater proportion than Graham found in 1932. Charles Schwab Corp., to name one example, holds $27.8 billion in cash and has a total stock-market value of $21 billion. Those numbers testify to the wholesale destruction of the stock market's faith in the future. And, as Graham wrote in 1932, "In all probability [the stock market] is wrong, as it always has been wrong in its major judgments of the future." In fact, the market is probably wrong again in its obsession over whether this decline will turn into a cataclysmic collapse. Eugene White, an economics professor at Rutgers University who is an expert on the crash of 1929 and its aftermath, thinks that the only real similarity between today's climate and the Great Depression is that, once again, "the market is moving on fear, not facts." As bumbling as its response so far may seem, the government's actions in 2008 are "way different" from the hands-off mentality of the Hoover administration and the rigid detachment of the Federal Reserve in 1929 through 1932. "Policymakers are making much wiser decisions," says Prof. White, "and we are moving in the right direction." Investors seem, above all, to be in a state of shock, bludgeoned into paralysis by the market's astonishing volatility. How is Theodore Aronson, partner at Aronson + Johnson + Ortiz LP, a Philadelphia money manager overseeing some $15 billion, holding up in the bear market? "We have 101 clients and almost as many consultants representing them," he says, "and we've had virtually no calls, only a handful." Most of the financial planners I have spoken with around the country have told me much the same thing: Their phones are not ringing, and very few of their clients have even asked for reassurance. The entire nation, it seems, is in the grip of what psychologists call "the disposition effect," or an inability to confront financial losses. The natural way to palliate the pain of losing money is by refusing to recognize exactly how badly your portfolio has been damaged. A few weeks ago, investors were gasping; now, en masse, they seem to have gone numb. The market's latest frame of mind seems reminiscent of a passage from Emily Dickinson's poem "After Great Pain a Formal Feeling Comes": This is the Hour of Lead -Remembered, if outlived, As Freezing persons recollect the Snow -First -- Chill -- then Stupor -- then the letting go.

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This collective stupor may very likely be the last stage before many investors finally let go -- the phase of market psychology that veteran traders call "capitulation." Stupor prevents rash action, keeping many long-term investors from bailing out near the bottom. When, however, it breaks and many investors finally do let go, the market will finally be ready to rise again. No one can spot capitulation before it sets in. But it may not be far off now. Investors who have, as Graham put it, either the enterprise or the money to invest now, somewhere near the bottom, are likely to prevail over those who wait for the bottom and miss it.

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