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Where's the bottom?
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September 19, 2001: 7:32 p.m. ET
We can't predict the coming months. But stocks are clearly oversold.
By Michael Sivy
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NEW YORK (Money) - There's an old rule of thumb that a bear market is over when the stock market drops hundreds of points on heavy volume, and then rebounds so much that it finishes the day in positive territory.
That didn't quite happen on Wednesday -- but it came close. After plunging more than 423 points, the Dow closed down just 144 points. The Nasdaq rallied even more strongly, but also closed in negative territory. So, by this indicator at least, the bear market is not quite over.
Where will the bottom be? Frankly, I don't know. Now we have to worry about totally unpredictable military events as well as the economy.
The key question is how much of the recent selloff reflects the economy's prospects and how much is psychological. In my view, there are four factors to consider.
Earnings Prospects
Even before last week's attack, many stocks were falling because outlook for third-quarter earnings was worsening. I thought that when results were finally reported in October, many companies might turn out to have done better than investors feared. And that would have started a market recovery.
Instead, many sectors will likely have an even lousier third quarter. And weakness may continue into the crucial holiday season. It is important to remember, however, that these problems are very unlikely to continue for more than six months. And longer term, the outlook is brighter, even for the hardest-hit industries.
Within a couple of years, demand will be back to normal for airlines, insurance companies, advertising and the like. If weak companies have been forced out of business in the meantime, dominant firms will have less competition and should enjoy higher profit margins.
The Economy
The second question is how big the effect will be on the economy. Again, I think it will suffer in the short run -- certainly through the end of the year. But the stimulus the economy is receiving right now is immense.
Not only is the Federal Reserve slashing interest rates, but so are the central banks of other industrialized countries. Both the Fed and the European Central Bank are pouring huge reserves into the banking system. In addition, the U.S. government will spend tens of billions of dollars on cleanup and rebuilding.
There's no way of knowing when all that liquidity will kick in. But whatever isn't needed by the economy will likely go to bid up the prices of financial assets, most notably stocks.
Military Risks
The immediate reaction to last week's horrific events has been to underestimate the resilience of the U.S. I don't want to minimize the appalling loss of life or the suffering of survivors. But the U.S. has immense strategic depth. No single conventional attack can permanently disrupt the country.
Moreover, our ability to deter future threats is considerable. Not only do we have overwhelming military capability, we also can lean on foreign countries that fail to crack down on terrorists. It may be impossible to stop lone bombers in shopping malls, but large-scale terrorism requires the support and co-operation of foreign countries -- and we can largely discourage that.
I think that the U.S. will pursue the terrorists aggressively, and more important, that the Bush Administration will be careful to lay crucial diplomatic groundwork. Still, you never know. A bungled U.S. operation or a retaliatory act of terrorism could give the stock market another kick in the teeth.
Valuation
Some bearish analysts compare share prices with the current year's earnings and conclude that P/Es are still too high. But I think that's a false analysis. If you look at prices based on cash flow or future earning power, most stocks now look cheap, including technology issues.
As one bellwether, consider a chart of the Nasdaq since the end of the 1990-91 recession. There is a very clear trend line that currently reaches to above 2200, more than 44 percent above Wednesday's close of 1,528.
Many analysts say that the Nasdaq is simply giving back the giddy inflation of share prices that occurred in the past few years. But I would note that the trend line was clearly in place before 1995 when Nasdaq P/E ratios began to be greatly over-inflated.
In short, I think we're dealing with a battered but deeply oversold market. Investors have been burned in all the growth sectors but drugs. They're rushing into super-safe Treasuries. And they're worried about getting blown up.
If you just think back two years, it's hard to believe how completely investor confidence has collapsed. And however hard it may be, try to imagine what things will be like a couple of years from now, once 90 percent of the current anxiety has passed. Seems to me we're going to see stock prices a lot higher by then, particularly for the technology issues that have been so badly battered over the past year. 
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