Hints of a market nearing bottom

In 1982, then Federal Reserve Chairman Paul Volcker ended a dramatic decline on Wall Street by abruptly reducing interest rates. Five years later, the current chairman of the Fed, Alan Greenspan, rescued investors after the Crash of '87 by flooding the economy with money.

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Related stories: 07/29/02 Bear lairs in a troubled market 07/25/02 Rumbles of double-dip recession

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What will it take to end the bear market of 2002?

In a word – if there is one word – self-correction.

Most analysts don't see any outside action or catalyst that will magically revive one of the biggest declines on Wall Street since the 1930s. Instead, it will largely require a shift in psychology – those who are panicked or pessimistic will have to get out.

In the paradoxical world of Wall Street, panic selling is often viewed as a good sign. The theory is that during a boom market many investors buy in the exhilaration of the moment and pay too much for stocks. Panic selling is a sign they have finally succumbed to the market, paving the way for a turnaround.

Some analysts now see signs the markets are near the bottom – though there could still be volatile ups and downs. Many panicked investors are, indeed, bolting. Corporations are expected to have better earnings in the near future.

And due in part to legislation passed by Congress last week, those earnings will likely carry more credibility.

Some companies, too, are spending billions buying back their own stock – in essence, saying they believe in their earnings and their future. If all of this leads to higher stock prices, the market will improve because investor psychology is finally turning.

"The higher the level of volatility, the higher the level of fear," says John Alexander, Breazeale professor of financial planning at Clemson University in South Carolina. With fear high, "I am confident in saying we have seen a short-term bottom."

Another sign the psychology may be changing: By the time plunging markets are over, dollar-inhaling bears have decorated the covers of magazines from Business Week to Newsweek.

Last week, the bear was on the cover of Baron's, a financial publication. In fact, at the bottom, bear markets have one thing in common: "Everyone hates stocks," says Jeff Hirsch, publisher of the Stock Trader's Almanac.

Experts point to other signs the markets may have reached this point. Small investors are bailing out of mutual funds, perhaps signaling that they are disgusted with their losses. "They aren't asking if I should buy, they're just selling everything," says Mr. Hirsch.

Defying rationality

At the same time, even though corporate earnings are starting to come in above expectations, prices are falling even on the good news. "A lot of it is the herd mentality," says Mr. Alexander.

In fact, Bill Dodge, chief investment officer at Delaware Investments in Philadelphia, thinks investors are going to be surprised when they see the improvement in earnings. "This time business has been aggressive at managing inventories and employment against the business environment," he says.

"Every bear market is different, and this time the earnings are improving and the market is the trailer to the car – it's usually the opposite."

Unlike at some other moments in history, many market watchers don't think a single move will cause the markets to shift direction. The Fed, for instance, could lower interest rates again.

But Donald Straszheim, president of Straszheim Global Investors in Santa Monica, Calif., thinks that would be a mistake.

"The problem is not that interest rates are too high, or we don't have enough fiscal stimulus," he says. "The problem is a lack of confidence and just the process of unwinding the earlier bubble."

One development that could improve the investment climate will be when CEOs have to start certifying their company's financial results, beginning on Aug. 14. Congress has also approved criminal penalties for executives who knowingly sign statements that are false.

"It lifts some of the uncertainty," says Gary Gensler, author of "The Great Mutual Fund Trap: An Investment Recovery Plan." "Now, CEOs will have their attention focused on the possibility they can go to jail," says Mr. Gensler, a consultant to Sen. Paul Sarbanes (D) Maryland who authored the legislation.

Still, other market observers see worrisome signs in the economy and corporate earnings. "The durability of the recovery is still questionable," says Mr. Straszheim, former chief economist at Merrill Lynch & Co.

With the stock market tumbling over the past six weeks, Straszheim, who thinks the market bottom is close, says the possibility of a double-dip recession has certainly increased.

"That's why to me the economic stats are more important than usual right now," he says. On Wednesday, the government will release the advance numbers on second-quarter growth. Later in the week, reports are due out on construction spending and July unemployment.

Warning signs

There's still plenty of pessimism around. Peter Schiff, president of Euro Pacific Capital in Newport Beach, Calif., is convinced the economy is not recovering from a downturn but preparing to go into a steeper one.

"The big problem is the extreme level of debt," he says, envisioning a gloomy scenario that includes personal bankruptcies and pension funds destroyed. He predicts the Dow Jones Industrial Average will plunge to 5,000.

This view is in the minority, however. "After every decline we see a snappy recovery, and then we go into a wide trading range for years," says Ralph Acampora, a market analyst at Prudential Securities. "This will do the same."