Why stocks are likely to move lower over next 6 months
Tuesday February 27, 6:28 pm ET
By John Shinal
Commentary: Why stocks are likely to move lower over next 6 months
SAN FRANCISCO (MarketWatch) -- As a reminder to investors, most economists are not predicting the end of the boom and bust cycles that have always been a part of the capitalist system.
The latest leg of the current bull market, which had pushed the Nasdaq Composite Index and other broad indexes pretty much straight up since August, has made it easy to forget that.
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So has the glut of liquidity that for several years has helped power markets around the globe higher and led to a wave of private-equity buyouts in the U.S. that have helped prop up share prices here.
Cheap money, combined with a record run for U.S. corporate profit growth and bubble-like euphoria about China, had lulled investors into complacency of historic proportions.
Before Tuesday, it had been 45 months since the S&P 500 had suffered a one-day decline of 2% or more. During the past 75 years, such days have occurred eight times a year, on average.
Then came the market plunge, when we were once again reminded that things that are too good to last never do.
Investors who think this was a one-day correction should consider that averages usually revert to their long-term means. I'm not sure exactly how many 2% daily drops we'll see during the next several years as that occurs, but my best guess is "lots."
Commerce is driven by human needs and emotions - people buy when they think they will get something in return for their money - from big-screen TVs to houses to stocks -- and sell when they convince themselves that holding what they have will cost them.
For that reason, markets will always be as capricious as human nature, which when it comes to investment decisions repeatedly cycles between fear and greed.
Several weeks ago, this column reminded readers of something MarketWatch first reported in July - that the American-traded shares of Chinese Internet companies were at bubble-like valuations and that their recent problems could be a sign of wider declines to come.
Tuesday, the trouble began in China, where the main stock index plunged 9%, the most in a decade. Yet many of the fundamental factors that have been helping drive U.S. stocks higher are beginning to falter.
Consider the following:
Profit growth decelerating
The string of 18 consecutive quarters of double-digit year-over-year growth in the operating profits of S&P 500 companies already ended in the fourth quarter or will do so in the first.
The fourth-quarter number currently stands at 10.03%, with more than 90% of the companies in the index reporting results. In the opinion of S&P analyst Howard Silverblatt, once all the companies file their 10-K annual statements with federal securities regulators, "We're probably not going to make it."
Granted, 10% profit growth is not a weak number by historical standards, but the tide has clearly turned.
For all of 2007, S&P expects profit growth of 7.53%, about half of the 15% figure for 2006.
Decelerating profit growth is a sign of a business cycle that is long in the tooth, as former Federal Reserve Chairman Alan Greenspan said Tuesday.
Home equity falling, loan defaults rising
For years, U.S. homeowners have been funding their spending with the rising equity in their homes, which functioned like an ATM machine that you could sleep and eat in.
That's over.
On Tuesday, just before the U.S. market meltdown, S&P reported that U.S. home prices fell 0.7% in the fourth quarter, the most since 1992.
With the U.S. annual savings rate below zero, which means consumers in this country spend more than they make in income every year, it's a mystery what will power consumer spending now that the ATM machine is broken.
At the same time, mortgage lenders afraid of a rise in the number of defaults are tightening lending practices, removing a significant chunk of home buyers (and mortgage refinancers) from the market.
Several lenders who specialize in so called sub-prime loans have already seen their shares pummeled after warning of higher losses. They'll soon have plenty of company.
"We think those problems will spread to other lenders," Silverblatt says.
The U.S. home market has been on a 15-year tear. Anyone who thinks a bull run like that works itself out in just one year may want to go back and look how long it took the stock market to recover from the late 1990s tech bubble.
The answer is - seven years next month, and counting.
An era of cheap money always ends badly
As MarketWatch columnist Mark Hulbert pointed out Tuesday - also before the big market plunge - the issuance of U.S. junk bonds reached record levels last year.
That was great for companies that wanted easy debt to fund investment.
However, periods of cheap money are usually followed by runs of rising bankruptcies, which signal economic weakness. To read how that dynamic fits into stock market cycles, read Hulbert's column here.
I could go on to mention how the current yield curve, which compares long-term interest rates to short-term ones, is signaling a 42% chance of recession during the next year, according the economists at the Federal Reserve.
Or how many investors who sold shares in Shanghai on Tuesday expect legislators in that country to try to rein in its economic expansion, which has been cruising along at an annual growth rate of 10% lately.
For tech investors wondering whether to buy, hold or sell right now, I suggest you pull up a three-year chart of the Nasdaq and judge for yourself whether buying after a big one-day drop -- near the top of a six-month run -- is a good idea.
I'm no chart expert, but individual stock charts for Nasdaq bellwethers like Cisco Systems Inc. (NasdaqGS:CSCO - News) Microsoft Corp. (NasdaqGS:MSFT - News), Oracle Corp. (NasdaqGS:ORCL - News) and others tell a similar story - all are showing dramatic short-term weakness after nice runs of at least six months.
U.S. stocks may go up on Wednesday. They may even go up the day after that. But the odds are good, given the deterioration of the fundamentals listed above and three-year chart trends, that sometime in the next six months most Nasdaq stocks will be lower than they are today by at least 5%.
Next week: the Q1 profit outlook for tech companies.
