Market Hits New Crisis Low

By E.S. BROWNING The Dow Jones Industrial Average broke to a new six-year low Thursday, dashing hopes of a quick market recovery and reawakening fears that the stock declines aren't over. The Dow industrials now have lost nearly half their value, or 47%, since their record close 16 months ago. They fell 89.68 points to 7465.95 on Thursday, dropping past the Nov. 20 low of 7552.29. With other indexes down similarly large amounts, investors are wondering how much longer the pain will continue. If past experience is any indication, it can continue for a while. Money managers and analysts who have studied past bear markets are warning clients that they aren't yet seeing the signals they would expect to see at a true market bottom. The Dow's 47% decline in the current 16-month bear market already is one of the biggest in the index's 113-year history. The only time it fell significantly harder was 1929-32, when it lost almost 90% of its value, and almost no one believes a similar calamity awaits this time. The classic sign of a bottom that many analysts and money managers are looking for is a period of frantic selling, followed by a sudden onset of heavy buying. They have seen the selling, but so far, they haven't seen the buying. The fear is that this means more selling is ahead. "For me to think we have tested those lows successfully and begun to recover, we need a strong rally. We need to come back with at least as much gusto as we went down," says Phil Roth, chief technical market analyst at New York brokerage firm Miller Tabak. The rally that began last November didn't have enough strength and breadth to signal the end of the bear market, Mr. Roth says. Thursday's declines left the Dow less than 200 points from the closing low of the past bear market, 7286.27, hit in October 2002. If it were to breach that level, it would be at its lowest point in 11 years. With economic indicators showing the economy still sinking and government officials warning that their repair efforts won't provide a quick fix, stocks posted broad declines. Financial stocks once again were pummeled Thursday, with the widely followed Keefe, Bruyette & Woods bank-stock index falling to its lowest level in 17 years. Citigroup Inc. dropped 14% to $2.51 a share, now down 32% in five trading days and at the lowest close since 1991. Bank of America Corp. fell 14% and KeyCorp 13%. Insurance stocks also posted sharp declines, with Hartford Financial Services Group Inc. off 25%. Paul Desmond, president of research firm Lowry's Reports in North Palm Beach, Fla., has used his own proprietary database to look at market bottoms back to the 1930s, and also believes stocks have further to fall. At almost every major market bottom two things happened, he says. First, investors engaged in panic selling, with declining stocks on the worst days accounting for 90% of trading volume and 90% of price moves. Then, days or weeks later, came an onslaught of panic buying, with rising stocks accounting for 90% of the volume and price moves on at least one day and often more than one. Those gains then were followed by continued heavy buying, albeit at less panicky rates. Mr. Desmond has a simple explanation for this phenomenon. First, he says, people who have lost confidence in stocks need to finish their selling. Until they do, weak-willed investors will kill rallies by selling out as stocks begin to rise. Then, confident investors need to step in and buy in a belief that stocks have become cheap. That produces the heavy market surge. "Until you have those two factors in place, you are unlikely to get a sustained advance," he says. As hedge funds have come to represent one-third or more of all stock trading, and as technical trading rules have been adjusted to make it easier for them to bet on stock declines, markets have turned more volatile and have given off some false signals, Mr. Desmond says. To double check, he tracks trends in rising and falling stock prices and volumes over longer periods. That research shows that rising stocks are accounting for less and less of the market over recent weeks, suggesting that investors aren't done selling. Jack Ablin, chief investment officer at Harris Private Bank in Chicago, which oversees $60 billion in investments, got a call Thursday from one of his money managers asking if now was the time to buy. The answer was no. Stocks have fallen a long way, Mr. Ablin said, but they can fall more. "Just because it is cheap doesn't mean it is a great deal," Mr. Ablin says he told his colleague. Early in December, as stocks were rebounding strongly and many people were betting the market had finally bottomed out in late November, Mr. Ablin boosted his group's stock holdings. The market didn't perform as he had hoped, and now he has pulled the extra money back out of stocks and moved it to high-quality corporate and municipal bonds. He had moved his firm's average portfolio to 50-50, evenly balanced between stocks and bonds, and was poised to move still more money into stocks. Instead, he now has put it back to 40% stocks and 60% bonds. Financial planners caution that it can be a big mistake for individual investors to try to time market tops and bottoms. A range of academic research indicates that people who do that almost always end up buying high and selling low. Many financial advisers have been urging clients who are investing for the long run to begin buying stocks now, on the grounds that they have fallen heavily and will almost certainly be higher in the next three to five years. What Mr. Roth's and Mr. Desmond's research suggests is that, if people follow that advice, they should brace themselves for the risk that their stocks will fall further before they begin to rise. While some may argue that stocks are cheap, history shows that even after a big decline, they can become even cheaper. An old Wall Street saying has it that markets can behave irrationally longer than investors can remain solvent. The most common method of determining whether stocks are cheap is to measure the price as a multiple of the company's profits. To smooth out short-term variations, Yale Prof. Robert Shiller measures price-to-earnings ratios using average annual profits for companies in the Standard & Poor's 500-stock index over the previous 10 years. Based on that method, the S&P 500 recently has been trading at about 15 times its members' average profits, close to the average level for the past 130 years. Using analysts' estimates of future profits, stocks are even cheaper. The trouble is that at the bottom of bear-market periods, stocks have often fallen well below historical averages. Mathematically, they should spend roughly the same amount of time below-average as they do above-average, and until late last year, they had been at above-average p/e ratios since 1990. This doesn't mean p/e ratios have to fall far below average immediately, but it does give some investors pause. Making things worse, many money managers fear that analysts' profit forecasts are too strong and will come down, as they have in past quarters. If so, p/e ratios based on past profits may not be the best indicator of future stock prices. The current bear market has lasted 16 months so far, making it one of the longest since World War II. On that basis, some analysts have argued that it must be running its course. But the previous one ran from early 2000 through October 2002, more than 2½ years. In the short run, investors will be watching whether the Dow rebounds from Thursday's low, or continues to fall. Investors had widely hoped that it would hold the November low. Investors also are closely watching the S&P 500, which still hasn't fallen past its Nov. 20 low of 752.44. It finished Thursday at 778.94, and if it were to join the Dow at a new bear-market low, that would add to the nervousness.