For a moment last week, it seemed that investor confidence, so crippled by the terrorist attacks and so crucial for the nation's economic well-being, was in the ascendancy again. One month to the day after the September calamities, the Standard & Poor's 500-stock index and the NASDAQ composite had returned to their pre-attack levels.
The rebounds were more than a ray of sunshine after weeks of gloom. Some investors also viewed the big bounce by stocks off their Sept. 21 lows as evidence that the recession we have entered will be over almost before it began. After all, everybody knows that the stock market rallies well before the economy does. Might not this powerful climb -- 13 percent in three weeks on the S&P 500 -- represent the turn?
It certainly could. Stocks started falling in the spring of 2000, and the time since is a good bit longer than most bear markets last. Since World War II, for example, the median duration of a bear market in the Dow Jones Industrial Average has been 11.6 months.
In addition, there is no doubt that government spending and the gung-ho interest rate policy of the Federal Reserve will bolster the economy at some point.
But investors looking for the turn in stocks can be easily burned. That danger is especially acute now.
Although stock prices have recovered, the fact is that Wall Street has not. Many traders and investors, sales forces and portfolio managers -- the crew that makes the market go -- are still wounded by what happened. Participants who would normally be hell-bent on identifying the next trade are distracted, passive, pulling back.
On the fixed-income trading desk at a major bank in New York, a managing director reported that his customers were doing half the volume that they had done before Sept. 11. And traders at brokerage firms everywhere are slashing their securities positions.
"The price of poker has gone way up because the risks are immeasurable," one bond trader explained. "You don't want to put on trades waiting for the next attack and you can't put on trades thinking the worst is over because if you're wrong it costs too much. So you do trades much smaller or not at all."
Although stock trading has been heavy in recent weeks, one hedge fund manager explained that much of the action appeared to be reaction. "There has been a fair amount of program trading related to asset allocations," the manager said. "It's been a long time since we've had a one-hundred-basis-point cut in the Fed funds rate in a month and, at the same time, the stock market dropped 10 percent. So everybody's asset allocation got really messed up."
With many market players on the sidelines, acting only when they have to, the market is more like a mirage. And it is extremely vulnerable to emotions. As a result, the market's ability to sense the coming economic recovery may be more dubious than usual.
"I think this is a rally to watch, but I don't think it's a rally to be bought," said Liz Miller, portfolio manager at Trevor Stewart Burton & Jacobsen in New York. "Even though the market tends to rally ahead of the end of a recession, what sparks that rally is corporations giving some view that they can foresee what their business trends look like. I have yet to hear the bellwether company saying there is a visible trend."
And with consumers cutting back on spending, an economic recovery will have to include renewed corporate spending. Yet economists at Goldman, Sachs estimate that if a credit cutback forces companies to finance their investment with internally generated funds -- as has happened in virtually every recession since 1950 -- capital spending could fall another 30 percent.
"Investors clearly want excuses to buy," Miller said. "But there's going to be plenty of time to participate in a recovery."
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