With Outlook Uncertain, Market Splits the Difference

By WALTER HAMILTON

June 15, 1999 12 AM PT

TIMES STAFF WRITER

Summer doesn’t officially start until Monday, but the stock market’s summer doldrums have been here for weeks. And they could last awhile, some Wall Streeters say.

Still, despite the recent surge in interest rates, few experts believe that a bear market--meaning a decline of 20% or more in key stock indexes--is on the horizon.

The technology-packed Nasdaq composite index has slid 9.6% from its April 26 peak, but the blue-chip Standard & Poor’s 500 index is a mere 5.4% off its May 13 high.

As has happened so many times in recent years, the market has become a split picture.

Large-cap growth stocks that have perennially led the market--especially technology, drugs and financials--have been pounded. America Online (ticker symbol: AOL; Monday close: $90.50) is 48% off its high, Pfizer (PFE, $95.13) is down 37% and Merrill Lynch (MER, $66.56) is off 33%.

But cyclical industrial stocks, energy stocks and, in particular, many small-cap and mid-cap stocks have either rallied in recent weeks or held up surprisingly well.

The S&P; small-stock index, for example, has slipped just 2.1% from its spring high.

Despite that strength in many sectors, however, some key “internals” of the market--such as trends in volume and investor sentiment--suggest more weakness ahead.

Stocks’ big problem, of course, has been the upheaval in the bond market and the widespread conviction that the Federal Reserve will boost short-term interest rates when it meets June 29 and 30.

The yield on the 30-year Treasury bond surged past 6% last week to its highest since 1997. Some experts believe that bonds are “oversold” and will stabilize soon. But no one expects a sustained bond rally that would feed a dramatic and broad rebound in stocks.

“The ugliness of the bond market is finally seeping through to stocks,” said Elaine Yager, technical analyst at Herzog, Heine, Geduld Inc. in New York.

Echoing the sentiments of other Wall Streeters, Brian Belski, chief market strategist at George K. Baum & Co. in Kansas City, Mo., believes the major stock indexes are midway through a downturn in terms of percentage losses.

But Belski and others don’t see a quick fix. Instead, the weakness in stocks may become more pronounced as the second-quarter earnings “pre-announcement” season begins, bringing the usual wave of companies warning of weak results.

The soonest the market could begin a genuine recovery, some experts say, is in mid-July, as second-quarter earnings announcements begin to roll out--assuming the reports overall look as good as many analysts expect.

“The market will wait this out until we get a decision on interest rates”--in other words, a sense of how high rates might go, said Joseph Battipaglia, market strategist at Gruntal & Co.

“But once we do, the market will focus on upcoming second-quarter earnings reports, which I think will be better than expected . . . and may be the fuel to spark a summer rally.”

Battipaglia likes such beaten-up big-name stocks as drug issues Johnson & Johnson (JNJ, $90.63) and Pfizer, financials such as Merrill Lynch, Chase Manhattan (CMB, $73.75) and American Express (AXP, $118.25), and transport stocks such as Union Pacific (UNP, $61), Northwest Airlines (NWAC, $31.06) and Airborne Freight (ABF, $28).

But other Wall Streeters believe a market recovery is further off. If uncertainty about the Fed lingers, good earnings may not be enough to turn things around, they say.

“In terms of pure numbers, it’s halfway over already,” Belski said of the market’s pullback. “But in terms of a time frame, it’s just beginning, maybe one-third over.”

Adds Charles Pradilla, strategist at SG Cowen: “What’s important isn’t whether they [the Fed] tighten or not, but what sign they give us as to what they have to do” to rates down the road.

Meanwhile, the market’s so-called internals trouble some pros.

For example, trading volume has been lackluster across the board lately, showing that investors are reluctant to commit to stocks.

“The lack of volume is certainly evidence of people not wanting to step up to the plate and make a decision,” Belski said.

Of greater concern, volume has been heavier on days when the market has dropped, and lighter on up days, Belski said. That shows investors are more willing to sell stocks amid gloom than buy them on recoveries.

It also is a sign that buying on the dips--a consistently successful strategy in recent years--has not been a good move lately. That’s clearest in Internet stocks, where a succession of lower highs and lower lows in share prices is proof that attempted rallies have failed.

Ironically, market sentiment gauges show professional investment advisors still very bullish. But in the contrarian ways of Wall Street, that’s a troubling sign because it suggests complacency.

With that backdrop, Belski remains wary of many big-name Internet-related stocks, including AOL, @Home (ATHM, $78.50), IBM (IBM, $115.50), Charles Schwab (SCH, $83.94) and Yahoo (YHOO, $119.25).

On the plus side, several telecommunications stocks are withstanding the market downturn, he noted. They include Ameritech (AIT, $69), Bell Atlantic (BEL, $60.88), Lucent Technologies (LU, $58.31), Nortel Networks (NT, $84.13) and MCI WorldCom (WCOM, $89.56).

Also on the bright side, small-cap and mid-cap stocks have held up impressively, a sharp contrast to their performances in last fall’s market plunge.

John Bollinger, head of Equitytrader.com in Los Angeles, thinks the smaller-stock rally will continue.

“We’re seeing the paradigm shift here away from the leadership of the past two years,” Bollinger said.

But what if the Fed does raise its key short-term rate, now 4.75%?

Some pros say a quarter-point hike by the Fed at its upcoming meeting would be good for stocks because it would eliminate the uncertainty shrouding Wall Street.

But others say it would only add more questions. “All we would get, once we have a [quarter-point hike], is guessing about what they’ll do at the August meeting,” said Richard Cripps, chief market strategist at Legg Mason Inc.

He favors cyclical industrial stocks such as AlliedSignal (ALD, $62.13), Caterpillar (CAT, $59.94) and Dover (DOV, $40.44). Among smaller stocks, Cripps likes Interim Services (IS, $21.75), United Rentals (URI, $25.50) and ITT Educational Services (ESI, $24.94).

Jeffrey Applegate, strategist at Lehman Bros., thinks the Fed may not act this month, but even if it does, “I find it awfully tough to make the case that it’s like 1994,” when the central bank doubled short-term rates in a 12-month period.

He still likes large-cap growth stocks such as Cisco Systems (CSCO, $107.81), EMC (EMC, $48.25), Lucent, AT&T; (T, $52.94) and MCI WorldCom.

Staff writer Walter Hamilton discusses the day’s market action regularly on the KFWB(AM 980)-Los Angeles Times Noon Business Hour. He can be reached at walter.hamilton@latimes.com.

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SH A Broad Decline Is Underway ...

Combined totals of rising stocks versus falling stocks on New York Stock Exchange and Nasdaq, each week:

Week of June 11:

3,526 rising

4,542 falling

Smaller stocks in general are holding up better than bigger stocks, and Internet stocks are suffering the worst. Percentage declines in key indexes from their 1999 highs:

S&P; small-cap: -2.1

S&P; mid-cap: -3.3

Dow industrials: -4.9

S&P; 500: -5.4

Nasdaq telecom: -8.7

Nasdaq composite: -9.6

Internet stocks*: -28.4

*Interactive Week index

Sources: Bloomberg News, Times research

Market Leaders and Laggards

Here are the stock industry groups up the most and down the most over the last month:

Leaders