Missing the mark in 2000, stocks look for a steadying hand ahead

Wearied by a market gone haywire, investors were greatly relieved in December when Alan Greenspan went on full alert, at the ready to cut interest rates to start the economy moving in the right direction again.

But investors must still wonder: Will Mr. Greenspan's hoped-for moves result in a swift and sturdy return to the good old days of steadily rising stock prices?

Many strategists say they believe that the early part of the year will be positive for stock indexes, if only because of the psychological boost a new year, a new president and Mr. Greenspan's avowed vigilance will give investors. But the jury is still out on whether the Federal Reserve Board chairman's anticipated monetary policy moves will turn around the economy — and stock prices — as quickly in 2001 as they have in periods of distress throughout the 1990's.

At issue is the nature of the current economic slowdown. The decline in the stock market may well prompt consumers to rein in their spending, keeping the economy from rebounding. And immense capital expenditures by corporations in recent years, much of which was financed by free and easy capital markets, may curtail new spending, putting a recovery in that sector in doubt. Both possibilities pose for Mr. Greenspan a set of economy- related challenges that are quite different from the market-related crises he has attacked so successfully in the recent past.

Like many strategists, Stefan Abrams, chief investment officer for asset allocation at the Company of the West, thinks that even though the economy is going to start the year quite weak, the financial markets will perform reasonably well as investors anticipate help from Mr. Greenspan on interest rates. "But somewhere in the middle of the first quarter," he said, "we're going to say, `Is the economy still deteriorating? Is the consumer still sated? And has business, through its high-tech spending, overbuilt the capital stock?' If so, then there could be cause for considerable concern because, if we need to jump-start aggregate demand, lowering interest rates may not do enough."

For the moment, investors are happy to be rid of stock market 2000. All of the broad market indexes ended the year in negative territory, but the indexes most heavily weighted toward technology fared the worst. The Dow Jones industrial average held up the best of the three most famous gauges, losing 6.2 percent compared with a 10.1 percent decline in the Standard & Poor's 500 index and a 39.3 percent plunge in the Nasdaq composite.

But even the devastation in the Nasdaq composite does not tell the whole painful story of 2000 in the market. Many of the stocks that had captured investors' fancies — particularly in the Internet sector — have lost three- quarters of their value or more. And as of Dec. 22, according to statisticians at Salomon Smith Barney, Nasdaq stocks had declined on average 54.4 percent from their 52-week highs, well below the 44.5 percent declines seen in these shares during the market crash of 1987.

Looking ahead, most individual investors seem certain Mr. Greenspan will deliver them from the stock market troubles seen in 2000. In a survey of 1,000 investors conducted late last month by Strong Funds, a mutual fund organization in Milwaukee, 42.6 percent said they believed that the stock market would rise at least 10 percent this year, while 34.8 percent said they expected it to be mostly flat. Only 20.3 percent think the market will decline by 10 percent or more.

The main reason for this optimism is investors' faith in Mr. Greenspan. Of those surveyed, 43.3 percent said that the Fed chairman would have the greatest impact on the market in 2001, well above the 35.6 percent of investors who said that corporate profits would be the driving force in the market. And if the president- elect has any delusions about who is in charge, only 6.8 percent of those interviewed said George W. Bush would be the prime mover of stocks in 2001, below even the 7.4 percent who thought world events would have the biggest impact.

The vote of confidence is undoubtedly pleasing to Mr. Greenspan and certainly well earned, as he has helped guide the economy to an expansion that last year became the nation's longest. But the expansion now seems to be fading, and it will take more than a few waves of his magic wand to restore the glow to the economy. Economists estimate, for example, that a year must pass before interest rate cuts work their way fully into the economy.

"An expeditious easing of monetary policy is necessary if the U.S. is to remain safely distanced from recession in the early part of the year," said John Lonski, chief economist at Moody's Investors Service. He estimated that the federal funds rate would have to fall to 5.75 percent, from the current 6.25 percent, before lenders would become less risk- averse and begin providing borrowers with money again.

Adding to the complexity of the Fed's task is the increasingly significant role that the stock market has played in recent years among consumers. In the third quarter of 2000, stocks held by individuals, private pension funds and state and local government retirement funds accounted for 61 percent of all financial assets owned in those quarters, according to Safian Investment Research in White Plains. Ten years earlier, stocks made up just 31 percent of all financial assets held by those individuals and institutions.

Because so many more Americans took up stock investing in the 1990's, the market's rise contributed to a strong economy. As stock prices soared, consumers felt wealthier, if only on paper. Many expanded their houses, bought second homes or purchased new cars, dishwashers and clothing. Manufacturers of those goods scrambled to meet demand.

Now that stock prices have plummeted, consumers may well ration their spending and perhaps even save some of their money, keeping economic growth in the doldrums. "The consumer is usually the last to slow down," said Lorraine T. Corbett, vice president at Safian Investment Research. "Once the consumer starts to pull back, that's when things start to decline."

Consumers certainly have reason to retrench. According to researchers at International Strategy and Investment in New York, investors have lost $3 trillion in market value since stocks peaked in March, a sum equal to one-third of the country's nominal gross domestic product.

What would really begin to worry Ms. Corbett and other economists is a change in the employment picture, with large numbers of workers being laid off. "If the job market stays where it is, you may not see a severe slowdown," Ms. Corbett said. "People may cut back a little bit because they want to wait and see what happens. But, if they're fearful of losing their jobs, that's something else."

Mr. Lonski echoed that view. "What worries me is how a declining equity market coupled with a slowdown in corporate profitability will affect hiring activity," he said. "If earnings slow significantly while stock prices are falling sharply, companies have all the more reason to downsize. Then it may be difficult to avoid a recession."

Although most economists expect economic growth simply to slow this year, some strategists wonder whether stocks are signaling a recession. Travails in the stock market are not always accurate in telling the economic future, but during the last four recessions, according to I.S.I., declines in the stock market preceded drops in gross domestic product.

During the severe bear market of 1974, for example, the S.& P. 500 fell 48.2 percent from peak to trough; in the recession that began in the middle of that decline, economic output fell 3.4 percent. In 1980, the S.& P. fell 17.1 percent and the recession that year shaved 2.2 percent off G.D.P. That was a mild recession, but equity investors had sniffed it out.

Judging from the past, if stocks have already bottomed, with the S.& P. 500 off 13.6 percent at year- end from its March peak, any downturn in the nation's economy could prove to be fleeting. But many strategists say they think that the early months of 2001 will be unsettling in the economy and that the elements for an acceleration in growth — including hefty bonuses and big tax refunds — are not in place this year. This suggests that the stock market may not make a big rebound.

Investors may take a wait-and-see attitude because it is not yet clear just what kind of slowdown is unfolding. In recent years, Mr. Abrams asserted, recessions have been a result of modest inventory bulges that were quickly worked off. More worrisome would be a slowdown based on extreme levels of overcapacity among the nation's manufacturers. That could result in a much deeper, more prolonged downturn.

"If we are not going through a short-term cycle caused largely by inventory but if, in fact, we've entered a capital bust, then the Fed is not going to be so powerful," Mr. Abrams said.

Capital spending for information technology, he noted, now amounts to 8 percent of gross domestic product and has been adding two percentage points or more to economic growth. Recently, Mr. Abrams said, growth in new orders had dropped to zero. If that does not improve soon, he added, the slump is going to be longer and deeper than people expect. What's more, lower interest rates won't help right away.

"It's not just a question of clearing a few Jeep Cherokees off the lot," he said. "The Fed can't just snap its fingers. It's going to take longer to take it through."

What kind of a stock market will investors encounter if the Fed's moves indeed prove to be less potent this year? In one respect, the market should look familiar: only those companies with solid earnings will perform well. Former tech glamour stocks, if they have no earnings, will continue to lose ground.

David Sowerby, portfolio manager at Loomis, Sayles & Company, said: "If I were to describe the stock market in 2001 in one word, it would be `balanced.' As in years past, good stocks with good fundamentals and good earnings will go up."

(http://www.nytimes.com/2001/01/02/business/02STOX.html?pagewanted=all)