"The Market" by Sheldon M.
Bell
Volume 2 - Issue 3 - September 30, 1998
August of 1998 was the worst August in stock market history. The stock market decline for the major indexes started on July 18, picking up steam in August.
For the thousands of stocks not in the major indexes, the bear market arrived even earlier this year, with the average New York Stock Exchange stock down more than 24% from their 52 week high by July 30th.
By July 30th the average NASDAQ stock had declined more than 35%. Indeed, fully 30% of the Big Board stocks and 51% of NASDAQ stocks were down 30% or more from their 52-week high.
For the small cap stocks of the Russell 2000 the blood bath started earlier. Small cap stocks have been in a free-fall since the end of April, with many stocks down 40%-50% by the end of August.
The bears finally have the upper hand even with a strong rally in September erasing 50% or more of the losses that many stocks took in August.
The question now is whether the bear market will be protracted or will it just be a blip on the graph. Investors have become more cautious, and are trying to determine if the recent stock market decline signals the end of the bull market that began 8 years ago.
A bear market is more than a number. If stocks should regain their losses in the short term, it won’t feel like a bear market to many investors. A true bear market is one that overall stock prices decline by 20% or more and stay down for a long period of time.
The last major decline in the stock market of 20% or more happened on October 19, 1987. On that day the Dow Jones Industrial Average plunged more than 20% . Today for that to happen the DJIA would have to decline more than 1600 points. The decline in 1987 was relatively short lived. Most investors who did not sell in panic regained all their losses within 15-18 months. The cause of the 1987 sell-off was rising interest rates and inflation. The Federal Reserve raised interest rates several times during 1987, but investors ignored the Federal Reserve tightening until it was too late in October of that year.
The last protracted bear market started in 1973 and lasted almost 8 years. From its peak the DJIA fell almost 50% from January 1973 to October 1974.
The bear market in 1973 was also triggered by high inflation and high interest rates, escalating oil prices, and finally the Watergate Affair.
Unlike the stock market decline in 1973 and 1987 the stock market decline in 1998 wasn’t caused by the usual forces of rising inflation, rising interest rates and an overheating economy as in the past, but rather by deepening world financial problems and the specter of deflation.
Since last July the global financial markets have been on a meltdown. The meltdown started with the Asian developing countries and quickly spread to South America, Canada and to Europe.
The straw that broke the camels back this August was the Russian financial market meltdown . The Russian Ruble (dollar) was allowed to devalue this summer and that it did, plunging more than 30%. This happened against a backdrop of political stalemate, as President Yeltsin fired his recently appointed premier Sorgei Kiriyenko after only four months in office. His new candidate Victor Chernomyrdin was rejected by the Russian Duma (congress), leaving a leadership void in a country that was our enemy until recently.
Investors around the world discounted the worst scenario possible , a communist leader or worst than that, a fascist dictator unfriendly to the west.
Oops! there goes the peace dividend. Fortunately for Yeltsin his new nominee Yevgeny Primakov was approved, so for the time being the political front looks more stable in Russia.
Against the backdrop of the market declines throughout the world the U.S. Treasury bond market has been the big winner. The turmoil throughout the World and in the U.S. stock market has led investors to the U.S. Treasury bond market as a "flight to safety". Interest rates on 30-year treasury bonds are the lowest in their history. Mortgage interest rates have also followed Treasury bond yields lower, are at near historic lows as well.
These low mortgage interest rates have bolstered the real estate market. Home ownership and new home building are growing at a very fast pace.
The Federal Reserve until recently, has been trumpeting their inflation mantra. However, the Federal Reserve hasn’t raised interest rates since March 25, 1997. At that meeting they raised the Federal Funds rate a meager ¼ percentage points to 5.5%.
On September 29th the Federal Reserve Board lowered the Federal Funds rate to 5.25%, a reduction of one-quarter point. This initiated a rally for all maturities in the next few days.
I haven’t mentioned the Clinton sexual scandal as it has little significance. It only helps increase the uncertainty that prevails in the financial markets. Hopefully it will be resolved in a sensible fashion and then congress can go on to more important things.
In the third quarter, excluding treasury bonds, most asset classes including: Real Estate Trusts, corporate investment grade, convertible and high yield bonds and small cap stocks faired poorly. Diversification didn’t add much of a safety net for most investors.
The winner for the third quarter was the utility sector. Utilities usually perform well in an environment of low interest rates.
If the Fed continues to ease and the U.S. economy doesn’t fall into a recession, the bull will return albeit a bit more subdued, so don’t panic. Remember the market has its ups and downs but will continue up as the economy grows.