Look Out Below

By Daniel Kadlec

So, were you doing any buying? If you were, you were pretty much alone as the stock market crumbled on Friday, breaking records on the down side with the same vigor it had displayed for so long while smashing standards going the other way. The question isn't just rhetorical. If you weren't buying this dip, what makes you think anyone else should be willing to step up to the plate?

For most of the past 10 years, stepping up hasn't been an issue. The masses in mutual funds have tripped over one another to buy stocks on every decline--including some doozies such as the aftermath of the Asia crisis two years ago. Hypnotized by a near perfect economy with plenty of jobs, soaring corporate profits and low inflation, investors always saw falling prices as a second chance to get stocks that had run away from them. The declines never lasted.

Maybe this one won't last either. Maybe the buyers will ride in on their white horses once again and save the day. It's simply too early to tell. What we know for sure, though, is that they didn't ride in last week, when the only tracks in evidence were left by the bears who trampled the NASDAQ, which fell a record 25.3% for the week, and the Dow, which on Friday suffered its worst one-day point loss--a, ahem, dip of 618 points.

We also know that those who tried to save the day two weeks ago on Terrible Tuesday--the day the NASDAQ fell 13.6% but got almost all of it back in a matter of hours--are now worse off for their efforts. The index finished on Friday at 3321, well below the week-earlier bottom of 3649. Investors who had smugly picked up Cisco at $64 and watched it rebound to $76 were by late last week the proud owners of a $57 stock. That will probably work out for them longer term. But raise your hand if you think such chastened buyers are going to bottom feed hungrily again real soon. Even if they want to, many exhausted their reserves buying during the earlier rout.

That's how bear markets go. Instead of every dip being a buying opportunity, every rally becomes a chance to unload. "For the first time in a while, people have got really scared," notes longtime bear Barton Biggs, chief global strategist at Morgan Stanley Dean Witter. He was expecting more selling this week, fueled by margin calls, margin-related liquidations and fidgety institutions. Mutual-fund investors, generally, have been holding on, Biggs says, though they haven't been aggressive buyers, and some fund companies got hit with redemptions. [What should you do? For advice on riding out volatile markets, see my column on page 92.]

Is this a bear market? It may be, and it may be all but over already. With information so quickly and extensively disseminated via the Internet, and with the low cost of trading, rapid market moves have become common. The time it takes to correct market excesses has condensed. So bear markets end as quickly as they start, and soon stock prices are on firm footing again. In fact, Wall Street hasn't witnessed a drawn-out bloodletting since 1983-84.

That's the new-economy view, anyway, and even some old-economy money managers buy it. "To maximize your long-term returns, you just have to step up and buy in a market like this," says Charles Carlson, co-manager of the Strong Dow 30 Value Fund. He was picking up Kodak, Philip Morris and Johnson & Johnson on Friday. New-economy money manager Garrett Van Wagoner, president of the high-octane Van Wagoner Funds, is another believer. "Now tech stocks are just outrageously highly valued rather than ridiculously highly valued," he says. "I don't mind buying ridiculously highly valued companies if they're growing 100% annually."

By traditional standards, though, if this is a bear market, it has a way to go. The bear designation occurs only when a blue-chip gauge like the Dow or Standard & Poor's 500 declines 20% over at least three months. As of Friday, the Dow had lost only 12.1% since peaking in mid-January; the S&P 500, 11.1% since peaking March 24. The NASDAQ, of course, is quite another story. From its close on March 10, it has fallen 34.2%. But the traditional definitions have never quite worked for this index. It has long been more volatile, and given that even on Friday the NASDAQ remained up 25% over the past 12 months, it's difficult to say there's been enough pain to label it a bear.

Labels don't really matter, anyway. If you bought Qualcomm at $200 in January and rode it down to Friday's $105, the market's a bear to you. And that kind of damage has hit more than just the tech stocks. Goodyear Tire is down 59% from its 52-week high; International Paper, 33%. The range of damage is what concerns analysts most. In January and February old-economy stocks were reeling, but new-economy stocks were rolling. Since early March it's gone the other way. But last week there was no rotation, nothing to cling to. Everything dropped in a buyer's boycott.

"Nobody wants to admit that there is something fundamentally wrong," notes Richard Bernstein, a market analyst at Merrill Lynch. "But there is, and this slide won't be over until investors recognize it."

Among other things, he's talking about the suddenly troublesome outlook for inflation. Technology and productivity gains have helped keep that market killer caged for a decade. But the Labor Department on Friday reported that consumer prices have climbed at a 5.8% rate so far this year--accelerating way more than the sub-3% level investors have come to expect.

The CPI number was a dagger in the market's heart. Although a single quarter's data aren't particularly meaningful, in this case they shattered investors hopes that Alan Greenspan might relent in his campaign of raising interest rates.

But the Fed chief may be cornered. He insists that his five rate hikes since June have been aimed at the hot economy, not the hot stock market, even though he has railed against the inflationary aspects of the market's wealth effect. If stock prices keep declining, at some point the wise course would be to cut rates. Greenspan employed that remedy with great success following the 1987 crash. But if he tried switching courses now, he'd have some explaining to do. It would look as though now that the market is down, he'd been targeting the ticker all along.

Inflation and higher rates are not the only drag on stocks. Earnings reports last week were mostly strong. But in this environment the market focuses on the blemishes. Motorola warned of trouble in the coming quarter, and Gateway and others failed to dazzle. There's also been a crush of new shares for sale as lockup provisions expire at companies that recently went public, meaning that lots of executives were free to dump their stock.

The big question now is whether the market damage will spill into the real economy, damping consumer spending. The worst-case scenario is that a fast drop-off in spending--faster than Greenspan anticipated--along with higher short-term interest rates could tip the economy into recession. Few predict that outcome. But "swings in stocks have almost 100% correlation with swings in retail sales," says Nancy Lazar, an economist at the ISI Group. She expects the economy to slow by summer.

One reason the impact could be more severe than many expect is that Americans save virtually nothing. For years savings--the amount left over after spending one's disposable income--or lack thereof haven't seemed to be a problem because people had money in the stock market, which was rising 20% a year. Who needs savings when wealth is building like that? But more than $2 trillion of stock-market wealth has been destroyed in the past few weeks. The nonsaving consumer who now has a portfolio marked down as much as 50% to 60% (if in tech exclusively) might rein in spending more sharply than expected.

Gary Denny, 56, a Montecito, Calif., architect and writer, certainly has such concerns. "I was thinking of buying a new car," he confides. "I don't think I will now." And he's one of the lucky ones. He took his $300,000 portfolio out of stocks two weeks ago, having suffered only a $10,000 loss. Now he's putting together a buy list but says he'll stand clear until he sees solid evidence that the market is rebounding. "My parents asked me if I think it's the beginning of another Depression," he notes.

To Renee Feiger, 50, a Los Angeles social worker, the gyrations of the stock market are of more than just academic interest. Feiger's ailing father, who has Alzheimer's, depends on his investments to pay for his home care. She planned to cash in some stocks in June. Now she's worried that she will have to sell more shares than planned to meet expenses and that she may run short in the long term. "It's very expensive to keep him at home with full-time caregivers," she explains.

One thing to keep in mind is that the economy did not fundamentally change on Friday. More people are employed than ever before. Productivity increases had been battling inflation to a virtual standstill before last quarter's oil-drenched increase, and oil prices may have peaked for the year. "You have to look underneath and ask, 'What's the greatest danger to the real economy?'" says economist Laura D'Andrea Tyson, dean of the Haas School of Business at the University of California, Berkeley. She isn't alarmed. "The real economy is in quite good shape," she says. "In normal circumstances one blip in the inflation numbers would be a nonevent."

That analysis will be comforting to those who want to view the market's punishment as temporary. In New York City, salesman Raheel Nazami owns up to losing $50,000 on paper last week but adds, "This is nothing. It will go back up." Tom Jacobs, a New Jersey executive, agrees. "While they got beat up pretty badly this week, I believe they'll come back by the end of the year." At 61, he sees no reason to rethink retirement plans. "I've been through this before, and I believe that the place to be is in the stock market," he says. "You can't put it underneath your mattress." Of course not. But last week that Simmons Beautyrest fund seemed worth considering.

--With reporting by Bernard Baumohl and Julie Rawe/New York and David S. Jackson/Los Angeles

With reporting by Bernard Baumohl and Julie Rawe/New York and David S. Jackson/Los Angeles