Here’s the long and short of it, according to two local stock-pickers.
The stock market is becoming a healthier place for long-term investors for the first time in a decade, thanks in part to the anxiety produced by the Enron scare.
But the current rally has yet to develop traction.
The 480-point advance in the Dow Jones industrial average in the last two trading sessions has Wall Street abuzz with optimism that major stock indexes will not suffer a third straight year of losses.
Worries about accounting shenanigans and illusive profit growth seemed to have moved to the back burner. Cash shifted to stocks amid signs manufacturing is rebounding from a long slump.
Evidence of an uptick in the computer industry–as measured by semiconductor demand–boosted tech stocks.
“It’s being driven by strong economic news that we’ve seen consistently over the last several weeks,” said Kathryn Vorisek, president and chief investment officer at Chicago-based Fiduciary Management Associates.
But the market rally has pushed a conventional measure of stock values into the stratosphere: The price/earnings ratio of the Standard & Poor’s 500 index reached 40.75 on Monday, up from 23.20 a year ago and more than twice the level many analysts believe is warranted.
The generous P/E ratio reflects weak corporate profits. “We’ve going to have to grow into these valuations,” Vorisek said.
Meanwhile, “We think in the near term we might see a little pullback because valuations seem to be a little stretched,” she said. “I think these high relative valuations are going to keep us in a trading range until earnings of the S&P 500 companies pick up.”
Nonetheless, for long-term investors, the picture is becoming brighter, said Christopher Faber, president of CFROI Global Advisors.
The second half of the 1990s saw an unsustainable and unhealthy decline in investor anxiety, he said. As a result of investor overconfidence, the inflation-adjusted, after-tax rate of investment returns that investors demanded to hold stocks dropped sharply compared with the rate of cash returns companies were generating, he said.
In theory, the two rates should be identical, as companies deliver just the cash returns stock market investors insist upon in order to hold stocks.
“The 1990s were an unsustainably positive period,” he said. “I never knew how, why or what would happen, but my suspicion was that convergence would happen.”
Since Sept. 11, anxiety levels have risen significantly, along with interest rates and gold prices. In effect, formerly complacent investors for the first time in a decade have begun to demand higher returns to compensate them for higher risks. Lower stock prices since March 2000 reflect the demand by more sober investors for higher investment returns.
At the same time, cash returns by companies have declined.
The process of shrinking the gap between investor demands and company performance is painful, as stock prices slide and profits slump. But after the terrorist scare and Enron meltdown, “the market rightfully got spooked,” Faber said.
“It makes me feel comfortable that the worst is behind us,” Faber said. “That doesn’t mean a bull market is going to start roaring back. But much of the disequilibrium of the ’90s is ending. The market is a much safer place for long-term investors.”
Monday’s action: Stocks rallied in heavy trading. The Dow Jones industrial average jumped 217.96 points, or 2.1 percent, to 10,586.82, the highest close since mid-July. The move compounded a 262-point gain on Friday.
Financial services, technology and basic manufacturing led the Dow gainers. So-called defensive stocks in food and health care slipped.
The broader Standard & Poor’s 500 index rose 22.06, or 1.9 percent, to 1153.84, pushing it into positive territory for the year. The Nasdaq composite index rallied 56.58, or 3.1 percent, to 1859.32, still nearly 100 points below water for the year.
Analysts issued upbeat assessments of old-economy bellwether General Motors, which gained $3.73, to $58.70.
On the flip side, shares of business software developer Oracle dropped $2.32, to $13.67, after it issued a profit warning.
New York Stock Exchange trading volume reached 1.61 billion shares. Winning stocks outnumbered losers by 7-3.
Nasdaq trading volume jumped to 2.3 billion shares, as winners topped losers by nearly 2-1.
Treasury securities slumped in the face of last week’s upbeat economic reports and the stock market advance.
Local news: Local governments in Illinois, Indiana, Michigan, Ohio and Wisconsin “will maintain stable credit quality in the wake of the current economic downturn,” Moody’s Investors Service concluded in a forecast of creditworthiness among local governments in the region.
Moody’s said governments in areas tied to cyclical industries, such as automobiles and steel, face pressures. But in general, these governments avoided overspending in the 1990s and built reserves against tougher times. Lower energy costs and interest rates have helped, Moody’s said.
Credit Suisse First Boston cut its investment rating on Lake Forest-based pleasure boat firm Brunswick to “buy” from “strong buy.” Shares hit a 2 1/2-year high in Monday’s session, gaining 55 cents, to $27.80.
Treasury auction: Interest rates rose at the Treasury’s auction of 3- and 6-month bills. The discount rate on 3-month bills was 1.76 percent, up from 1.73 percent last week. The rate on 6-month bills was 1.89 percent, up from 1.85 percent. The coupon-equivalent investment rates at Monday’s auction were 1.79 percent for 3-month bills and 1.93 percent for 6-month bills.
