Crisis of confidence leads to fears
Source:   Publish Time: 2011-08-09 00:10   1073 Views   Size:  16px  14px  12px
Crisis of confidence leads to fears of bear market

Crisis of confidence leads to fears of bear market


NEW YORK — The downgrade of the USA's once-pristine triple-A credit rating got a failing grade from Wall Street on Monday, as stocks suffered their worst plunge since December 2008, leaving the fragile stock market on the brink of another bear market.

The fallout from the nation's first-ever downgrade to AA+ hit global stock markets hard Monday in the first day of trading since rating agency Standard & Poor's made the U.S. pay for the federal government's inability to agree on a credible plan to rein in its spiraling deficit.

Investors in Asia, Europe and the USA all fled risky stocks in panic selling as news of the downgrade, coupled with the ongoing debt crisis in Europe and recent signs of a slowing economy, sapped the confidence of investors.

The Standard & Poor's 500-stock index fell 6.7% Monday, extending its loss from its April 29 bull market high to 17.9%. That steep, sudden and scary drop has reopened the psychological wounds investors suffered back in the 2007-2009 bear market, when fears of a financial system meltdown knocked the market down nearly 57%, erasing the financial security of millions of Americans.

"This is clearly a Blue Monday. Nerves are raw, and there's clearly panic in the air," says Paul Schatz, president of money management firm Heritage Capital. "So many people sat through the '08 (market plunge) without making a single move. It is unsettling, and people don't want to live through it again."

The selling pressure trimmed 635 points, or 5.6%, off the Dow Jones industrial average, which closed below 11,000 at 10,810. The point drop ranks as the sixth-largest in the Dow's history.

In an ominous sign, the S&P 500 is nearing the 20% drop required for Wall Street to officially designate the recent carnage as a bear market. The sheer velocity and ballooning size of the losses not only accelerate the stock market's downside momentum, they also increase the odds that a dreaded bear market will occur, according to data from Ned Davis Research.

In the 42 "severe corrections," or a drop of 15% or more, the S&P 500 has morphed into a bear market 60% of the time, NDR data going back to 1928 show. And the average decline in those bear markets was almost 36%.

There's no reason to wait for the market to cross the 20% threshold, says Richard Suttmeier, chief market strategist at "Stocks are already in a bear market."

The broad market, he says, has already broken the uptrend that was in place since the March 2009 lows. The downside of that fractured stock chart pattern is that a new trend heading in the opposite direction occurs.

"The S&P credit downgrade, which has never happened before, was a game changer," says Suttmeier, who sees nothing on the horizon that will entice investors to buy stocks.

Counterintuitive reaction?

Ironically, the 10-year U.S. Treasury note, which was downgraded by S&P and can no longer be considered a risk-free investment as a result, actually rose in price, as jittery investors bought bonds in search of safety. That buying, which knocked the yield down to 2.34%, from 2.57% on Friday, sent a message that the U.S. is still considered a safe place to deposit cash and investors will get paid by the U.S. government.

"It shows the U.S. is still creditworthy," says Chris Konstantinos, director of risk strategy at Riverfront Investment Group.

Edward Yardeni, market strategist at Yardeni Research, says the credit downgrade caused a big drop in investor confidence: "We are clearly in a crisis of confidence around the world."

Panic was so widespread that a widely followed "fear gauge" skyrocketed 50% on Monday to its highest closing level since the bottom of the last bear market on March 9, 2009.

Other market watchers cited the credit downgrade as the catalyst that got investors to rethink their bullish global growth story and to start to seriously entertain the notion that the U.S. could indeed slump back into recession.

A rally this week?

Still, many investment strategists say that despite the fact that the S&P 500 is just 2.6% from a 20% total decline from its 2011 high, it is still premature to say the current fall will deteriorate into a nasty bear market.

"The weak start was expected following the debt downgrade," says Tim Hayes, an investment strategist at NDR. "But I would still put this in the correction category. The market has gotten very oversold, with high pessimism, so the market should start to rally this week. While not ruling out a new bear market, I think it would be premature to draw that conclusion."

But the red ink registered on U.S. stock indexes tells a story of a market in retreat, at least for now.

•All 500 stocks in the S&P 500 index finished lower. All 10 sectors were down. And four of the 10 sectors — energy, materials, industrials and financials — are now down more than 20% from their highs and in bear markets.

•All 30 blue-chip stocks in the Dow also finished in negative territory.

•Small stocks got mauled. The Russell 2000 plunged 8.9%. It is now down 24.7% from its April 29 high and firmly in bear market territory.

•The Wilshire 5000 stock index, which basically covers the entire stock market, fell 7.1%, shedding $1 trillion in market value.

Nearly a third of the Wilshire's losses came after President Obama's televised speech in the afternoon, which suggests Obama was unsuccessful in stemming the crisis of confidence plaguing markets, says Yardeni.

Oil also got crushed on fears that the global economy is slowing. A barrel of crude fell 6.4% to $81.31.

The only assets that rose in value were those considered low-risk. The big winner was U.S. government debt, which still found plenty of buyers despite losing its AAA rating. Gold continued its ascent into new-high territory, rallying $61.40 an ounce to $1,710.

The stakes are rising for investors. The difference between a correction and a bear market has to do with the amount of financial pain inflicted. Going back to 1946, corrections have caused only average declines of 14% and have taken only 3.6 months for investors to make back their losses, S&P data show. In contrast, bear markets slice 28% off the value of the market — and it takes nearly two years to get back to even.

Don't forget Corporate America

There are some Wall Street strategists who insist that the selling is panic-driven and does not jibe with the still-positive drivers of stock prices.

Brian Belski, chief investment strategist at Oppenheimer, argues that the strength of Corporate America, which is entering this tough patch with strong earnings momentum and a mountain of cash (S&P says non-financial companies have $963 billion), is the main reason he is not altering his current investment outlook. He is still sticking with a year-end price target of 1325 for the S&P 500, which would amount to an 18% gain from current levels.

"At times like these, investors often ignore the positives," he says. "U.S. corporations are generally in a much better place than the rest of the world."

In the current quarter, 72% of the companies that have reported second-quarter profits have beat expectations, says Thomson Reuters. And analysts expect companies to grow earnings in the high double digits in the final two quarters of the year. (Bears, however, say those expectations are too lofty given the latest soft patch in the global economy.)

Right now, the pessimistic market is pricing in a high probability of another recession, says Riverfront's Konstantinos. If the market is wrong, than the current downturn could present a good buying opportunity, he adds. "We have an itchy finger to buy," he says.

But not quite yet. The "impulsive" selling points to more selling ahead. For now, the firm is in what he dubs "risk-management mode." Translation: It has sold stocks in its tactical model portfolio and now have 20% of the portfolio in cash, up from 3% to 4%.

What would make him put some cash back to work in stocks? He would like to see valuations tumble some more to provide a good entry point with lower risk. After Monday's sell-off, the market is selling at 11.3 times 2011 estimated earnings.

Konstantinos would also be more bullish if the European Central Bank took more aggressive steps to quell the debt crisis in Europe. He is also hoping the Federal Reserve can provide the market with some positive guidance today after its meeting.

Don Luskin, chief investment officer at TrendMacro, says there are two fears on Wall Street. One is psychological. Investors fear that no matter what the government does to fix the debt problems, it won't be good enough for rating agencies. "It creates fear: What if our destiny is to go down the drain?" He says investors are also unsure whether there will be any unintended "systemic consequences" of the S&P credit downgrade that will cause markets to freeze up like they did after Lehman Bros. failed in fall 2008.

"If I am right and a week goes by and there are no systemic consequences and there are no sharks in the pool," that should bring buyers back into the market.

Luskin says another potential positive outcome is that the credit downgrade will serve as a "wake-up call" for lawmakers to work up good policy solutions to the nation's debt crisis.

But bears like Suttmeier say caution is the best approach when it comes to the stock market. "The declines can get worse than 20%," he warns.






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