Sat, Oct 13, 2001 page19

• When markets ignore news of calamity, go with the markets

  • By Caroline Baum / BLOOMBERG
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  The US dollar and stocks are rallying; bonds are getting hit. Short-term treasuries are faring even worse. It sure smells as if something is afoot.

  Both the Standard and Poor's 500 Index and the NASDAQ Composite Index have "filled the gap," technical chart talk for recouping the ground lost following the Sept. 11 attack on the World Trade Center.

  The Dow Jones Industrial Average is still 130 points below the intraday low on Sept. 10.

  It's hard to say that the news on the economy and corporate earnings has been good. Less bad than expected, maybe, but not good.

  The number of people filing an initial unemployment claim fell 67,000 to 468,000 last week, a bigger drop than expected. The Labor Department said the decline might have been distorted by a seasonal adjustment problem in the first week of the new quarter (claims soared in the previous week to 538,000, muting the usual first-month-of-the-quarter jump).

  The four-week moving average of initial claims rose to a decade high, as did the number of people receiving jobless benefits. In other words, folks on the dole ain't getting off quickly.

  Chain store sales fell 0.8 percent from a year ago, making it the worst September in 30 years, according to the Bank of Tokyo-Mitsubishi chain store sales index.

  On the equity front, a few companies, such as General Electric Co and Yahoo, met or exceeded third quarter depressed earnings forecasts this week, which was considered a positive. But it's not as if these companies were tearing up the tarmac.

  GE's third quarter net income rose 3.2 percent while Yahoo lost US$24.1 million last quarter, which was a fourth consecutive quarterly loss.

  What's attracting more attention than the news itself is the reaction to the news. Traders and analysts are eying the market's rally, which has lifted the major indexes 5.5 to 7.7 percent from the closing levels on Sept. 17, the first day the stock exchange traded following the attack. When the news is going in one direction and the market in another, it's time to take note.

  The interaction between price action and news isn't always in the same direction. Sometimes the market clearly reacts to news, especially if it is unexpected: events, such as the Sept. 11 terrorist attack; economic reports, if they are surprisingly weak or strong; comments by policy makers that indicate a shift in stance.

  Then there are times when that relationship breaks down.

  Stocks fail to fall and bond prices fail to rally on sour economic news.

  It's at times like these, when the markets don't react in an expected fashion, that everyone sits up and takes notice. Such a divergence gives rise to the conclusion that "the bad [good] news is already priced in," to borrow a familiar Wall Street saw.

  Are markets done with the "recession" and on to the recovery? Paul McCrae Montgomery, a money manager and market analyst at Legg Mason Wood Walker Inc in Newport News, Virginia, thinks they just may be. Using a "headline indicator,'' which is similar to the magazine cover indicator in its contrarian nature (by the time a trend is sufficiently entrenched to grace the covers of the nation's weeklies, it's pretty much over), Montgomery cited a Richmond Post Dispatch headline from Sept. 22: ``Market is in a free-fall.'' This indicator ``tends to act immediately,'' unlike the magazine cover indicator, which usually sees the market go in the direction of the cover for a few weeks before reversing, Montgomery says.

  The coincidence of abject pessimism, reflected in news headlines, and the autumnal equinox, a phenomenon he believes coincides with volatility or directional changes in markets (exactly which markets is up for grabs) leads Montgomery to believe that the low is in for stocks.

  "The pessimism reached an extreme last month," says Tim Hayes, global equity strategist at Ned Davis Research in Nokomis, Florida. Hayes uses a composite indicator of sentiment, which includes things like the put/call ratio and adviser sentiment surveys, to measure extremes in the market.

  It's when everyone is leaning in one direction -- either very long or very short -- that markets tend to turn, even when it seems counterintuitive to the news.

  It's no surprise, then, that financial variables are included in the index of leading economic indicators. Specifically the S&P 500 Index and an interest-rate spread (the difference between the 10-year Treasury rate and federal funds rate) are two of the 10 components in the LEI.

  It's too soon to say the rally off the Sept. 21 low -- 14.3 percent for the Dow Jones Industrial Average, 13.6 percent for the S&P 500 and 19.6 percent for the NASDAQ -- represents the end of the decline and the start of a sustained trend upward. However, the market's ability to buck the trend of dire forecasts, especially the determination that a recession was upon us following the Sept. 11 attack, is a sign the market expects a brighter future.
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