Thu, Oct 11, 2001 page19

• October has a history of inciting crashes, but this year is different

  The market has seen a major decline, valuations have been brought back to earth and the Fed is lowering interest rates. This is not the stuff of which crashes are made

  • By John Dorfman / BLOOMBERG
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  October is the month when investors worry most about a market crash. After all, the historic crashes of 1929 and 1987 happened in October. So did the mini-crash of 1989, and some bad jolts in 1932 and 1937.

  But I will go out on a limb and say that there won't be any October crash this year. In fact, stocks will be up this month.

  I know that conventional wisdom says the US was teetering on the brink of a recession and the terrorist attack of Sept. 11 pushed us over the brink. Maybe that's true and maybe it's not, but most recessions aren't accompanied by stock-market crashes.

  They are accompanied by slow, grinding bear markets. And we have already had one of those.

  On March 24 of last year the Standard & Poor's 500 Index, which is as good a gauge of the overall market as any, hit a peak of 1,527.46. On Sept. 10, the day before two suicide planes slammed into the World Trade Center and one into the Pentagon, the S&P closed at 1,092.54.

  So the index had already lost more than 28 percent of its value before the terrorists struck.

  In the first five trading sessions following the attacks, the S&P declined another 11.6 percent to 965.80, bringing the total decline to more than 39 percent. But in the next ten sessions, stocks made up most of the ground they had lost following the attack.

  As of Friday, the index stood at 1,071.38. So the decline in the 15 sessions since the terrorist attack amounts to only 1.9 percent.

  It would be foolhardy to say that the declines are necessarily over. Certainly if there is another successful terrorist attack public confidence would be shaken and stocks would fall.

  However, I believe we are closer to a bottom than to a top. I have been adding to stock holdings for many of my clients in the past three weeks, and I have eliminated some short positions (bets against selected stocks). Among the stocks I have been buying are Oshkosh Truck Corp, Boeing Co and Midwest Express Holdings Inc.

  As you can see from the latter two, I reject the argument that Americans will never fly in large numbers again.

  Because stocks were so expensive in March of last year, they are still not especially cheap, even after the big decline of the past 18 months. However, working off excessive valuations can be accomplished in two ways -- by price declines and/or by the passage of time. Over time, stocks may "grow into their valuations" as earnings catch up with prices.

  I believe that the falling prices we have seen for the past 18 months will begin to abate now, and that we are entering the "time" phase of this bear market. I suspect we will see a year or two of choppy, zigzagging price action with no real direction.

  That might be how we complete the correction of the excesses of the late 1990s and early last year.

  During this choppy phase, I believe it will be possible, though difficult, to make money. Quite a few individual stocks seem to me to be bargains now. I think adept investors will be able to eke out profits by stock selection, by shrewd (or lucky) market timing or by selling short some of the stocks that remain overvalued.

  Justifiably, headlines focused on the big stock market decline in the first week of trading after the terrorist attack.

  However, when you look at the month of September as a whole, the S&P's 8 percent decline was not of historic proportions. Since the beginning of 1926, there have been 22 months in which the S&P 500 declined 10 percent or more.

  By the way, of the 22 months that saw 10 percent declines or worse, three were Octobers. That is more than you'd expect by chance, but it's not enough to really uphold October's fierce reputation.

  Look at the table of the S&P 500's ten worst declines in a calendar month. As you see, the two famous crash months, October 1987 and October 1929, both make the list, but they rank only fifth and seventh. A steady decline can do more damage than a sudden, violent crash, as the six examples from the 1930s show.

  The stock market usually reacts more strongly to economic news than to political or even military crises. The market drop in the first week of trading following the terrorist attacks of Sept. 11 was a bigger reaction than stocks had to Pearl Harbor, the Kennedy assassination, the Cuban Missile Crisis or the build-up for the Gulf War in 1990.

  The triggers for a market decline or a crash can be numerous.

  One of the most common and most important is rising interest rates. That unpleasant influence played a part in the crashes of both 1987 and 1929. It is not present today.

  When the Federal Reserve lowered the federal funds rate to 2.5 percent on Oct. 2, it was the ninth time this year that the central bank has acted to lower rates and it resulted in the lowest rates since John F. Kennedy was president.

  In short, we have already seen a major stock market decline, stock valuations are not cheap but are better than they were, and the Fed is aggressively lowering interest rates. In my opinion, this is not the stuff of which crashes are made. In fact, it is a pretty decent time to invest.

  For your information

  S&P's 10 worst declines

  * September 1931 -- 29.73% * March 1938 -- 24.87% * May 1940 -- 22.89% * May 1932 -- 21.96% * October 1987 -- 21.52% * April 1932 -- 19.97 % * October 1929 -- 19.73% * February 1933 -- 17.72% * June 1930 -- 16.25% * August 1998 -- 14.46%
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