'Buy the dips': The Wall Street cliche that has worked like a charm

One of the biggest fears as the stock market began to rebound late last winter was that sellers would swarm just as soon as the advance lost its momentum. Who would want to risk hanging around for another meltdown?

Instead, this now eight-month-old rally has been powered by classic bull-market thinking -- which is, you don’t sell the dips, you buy them.

As the accompanying chart of the Standard & Poor’s 500 index shows, the market has pulled back on numerous occasions since early March, but none of those declines has snowballed. The selling has quickly ebbed and buyers have regained the upper hand.

The most recent pullback occurred from Oct. 21 to Nov. 2, when the S&P fell 6.6% (as measured by its intraday highs and lows).

It was another gift to sidelined investors: Since the Nov. 2 low the S&P is up 7.9%. It closed at a 13-month high of 1,110.32 on Tuesday.

The simple definition of a bull market is when more investors want in than want out. We know the fundamental reason why that has been so in this year’s rebound: Investors sensed that the economy would begin to emerge from recession, which it has, even if the labor market has been left behind. A turn in the economy was expected to help corporate earnings  improve, which they have, though in large part because of brutal cost-cutting.

Meanwhile, short-term interest rates remain near zero and long-term rates have tumbled, further bolstering the case for equities. Rock-bottom short-term rates also power the "carry trade," encouraging speculators to borrow to buy stocks and other risky assets.

The market’s performance also has fueled plenty of conspiracy theories, usually centered on the idea that the Obama administration, the Federal Reserve and, of course, Goldman Sachs are making sure that stocks stay elevated. (If only it could be that easy.)

With 2009 winding down there’s another factor supporting the market, and it may trump everything else for the time being: Professional money managers can’t afford to take the chance of paring back sharply on stocks, for fear that this rally will keep going and leave them behind. And those who aren't in need to get in.

After the horrors of 2008, a money manager who doesn’t keep up with the market’s comeback this year is facing his or her greatest risk of all: the risk of unemployment.

Although many individual investors have stayed away from stocks as the market has climbed, they only have to answer to themselves, or maybe to their spouses. A fund manager who is lagging will have to face the wrath of aggravated clients for a second year in a row.

"This market is a nightmare for under-invested portfolio managers," says Jeff Saut, chief investment strategist at brokerage Raymond James & Associates. That, he says, explains why it doesn’t take much of decline in share prices to pull in buyers: Managers with cash really do see any dip as a gift.

A bigger sell-off is out there, somewhere. But Saut doesn’t see it coming soon.

His message to clients, he said, is: "You can get cautious, but don’t get bearish."

-- Tom Petruno

Productivity soars, and workers wonder: Where's our share?

The government’s report today on worker productivity growth in the third quarter shows, yet again, the benefit businesses are reaping from slashing millions of jobs in the Great Recession.

Productivity -- output per hour worked -- rocketed at a 9.5% annualized rate in the latest quarter, well above the 6.5% growth Wall Street had expected.

Michael Darda, chief economist at investment firm MKM Partners in Greenwich, Conn., put the report in perspective in a research note today:

"Productivity growth has exploded upward at an 8.2% average annualized pace during the last two quarters, the fastest two-quarter surge off a recession trough since 1961. Unit labor costs, typically the flip side of the productivity numbers, collapsed at nearly a 6% annualized rate during the last two quarters -- the largest two-quarter decline off a recession trough on record. Since corporate profits are directly related to productivity growth and inversely related to unit cost growth, this data is good news for earnings.

"However, the recent productivity gains are not sustainable. At some point, hours worked and payrolls will have to rise in order to meet stepped-up production schedules. As this occurs, income growth should recover, allowing households to spend more even if they are setting aside a larger fraction of their income in savings."

Darda is an unabashed bull on the idea that the economic recovery can and will become self-sustaining -- and that job growth will follow.

Although a turn in the labor market may not be apparent in Friday’s report on October employment, Darda said, "We continue to believe that net job losses will end in the next three months and that net job growth will restart within the next six months."

But Steven Ricchiuto, chief economist at Mizuho Securities in New York, says the danger is that companies have fallen into a trap of "excessive cost cutting."

From a research note Ricchiuto wrote today:

"Specifically, the corporate sector’s single-minded focus on driving up next quarter’s earnings is resulting in an unsustainable shift in the share of national income accruing to the corporate sector at the expense of households. The more companies strive to cut cost, the more workers they fire and the lower the future demand for their product.

"The more household income is squeezed the more consumers will have to save in order to complete their required balance sheet adjustment. This in turn limits top-line revenue growth at companies and makes the turn back to cost cutting to boost earnings [create] a negative feedback loop that sets the stage for a double-dip scenario."

It’s understandable that companies remain fearful of spending money, but Ricchiuto’s concern is valid: Squeezing your remaining labor force to death isn’t a recipe for long-term business success.

Who wants to go first to expand their payroll?

-- Tom Petruno

Why the 'disconnect' between the economy and your 401(k) could persist

The stock market has a serious lot working against it at the moment: fresh doubts about the economic recovery, a rebounding dollar and the general sense that share prices are overdue for a pullback after a nearly eight-month-long advance.

Including Friday's slump, the Standard & Poor's 500 index is off 5.6% from its one-year high reached Oct. 19, and talk of a bigger drop is rampant (again).

But if institutional investors remain reluctant to sell equities, it's because they see that plenty of companies are looking better than the U.S. economy as a whole.

How is that possible? In my weekend column in the Times, I note how corporate balance sheets have improved this year thanks in part to the plunge in long-term borrowing costs -- which has been abetted by small investors' ravenous demand for bonds.

Wall Street also can't ignore the turnaround in corporate earnings, even though the bottom line has been fattened largely because of vicious cost-cutting at workers' expense.

Why is the U.S. still losing jobs? As economist Allen Sinai put it: Companies are "making good money without people."

That isn't a path to long-term prosperity, but remember: Many major American businesses (the kind you probably own in your 401[k]) are betting on faster growth abroad than at home, anyway. And their biggest investors, for the most part, don't care where in the world they make money, as long as they make it.

I also note in the column that, as long as doubts persist that the U.S. economic recovery can sustain itself, the Federal Reserve (which meets this week) will remain in a supporting role with near-zero short-term interest rates.

And with "cash" investments paying nothing, and long-term bond yields low, it's that much harder for investors to bail on stocks en masse.

So, could the market pull back further this month? No question. That would surprise virtually no one.

But could we face another crash that obliterates your 401(k)? Highly unlikely in the near term.

Read the full column here.

-- Tom Petruno

If this is the market 'correction,' it isn't much so far

The stock market may feel awful, but memories tend to be short on Wall Street: Measured by most major indexes, the pullback over the last two weeks still is shy of the last significant decline, from June to mid-July.

The Standard & Poor’s 500 index, which slumped almost 2% to 1,042.63 on Wednesday, is down 5% since it reached a one-year closing high of 1,097.91 on Oct. 19.

By contrast, the sell-off that hit the S&P from June 15 to July 10 took it down 7.1% before buyers swarmed again.

The average New York Stock Exchange issue is down 6.3% since the NYSE composite index hit its recent high Oct. 19. The index was off 9% from its June high to its July low.

So we're still quite a ways from even a classic "correction" in a bull market, meaning a short-term drop of 10% to 15% in major indexes.

In early July, as now, many investors feared the market was on the verge of a deep decline because of worries that the economic recovery was running out of gas. But as second-quarter corporate earnings reports rolled in beginning in mid-July, the bulls were able to regain control, and they stayed in charge through August and September.

Third-quarter earnings reporting season also got off to a strong start, lifting the market in the first two weeks of this month. But in the last few days some high-profile reports, including from software giant SAP and Goodyear Tire, have disappointed investors, contributing to the darkening mood -- and fueling fresh predictions of a steep market sell-off.

Weaker-than-expected economic data, including the new-home-sales report Wednesday and a consumer confidence report Tuesday, also have hurt the optimists' case.

Stop me if you've heard this one: Many market bulls say they would welcome a classic 10% to 15% correction to take some of the froth out of share prices and attract new money from the sidelines. In theory, so many cautious investors have been waiting for a pullback that there should be plenty of cash ready to jump in as stocks cheapen.

But how cheap is cheap enough?

Consider: The 7.1% drop in the S&P from mid-June to mid-July took it down to 879. This time around, the market is falling from a much higher level. Even if this pullback were to slash a painful 15% from the S&P 500's recent high, the index would be at 933 -- still 6% above its July low of 879.

-- Tom Petruno

Photo: Traders on the NYSE floor Wednesday. Credit: Richard Drew / Associated Press

City National earnings fall by more than half

Business lender and private banker City National Corp. said this afternoon that its third-quarter net income declined by more than half as a result of losses on real estate lending.

The Los Angeles bank said its worst problems were shifting from home-builder loans to nonresidential-construction loans, reflecting the troubled economy's shifting.

In its earnings release, City National said it earned $8 million during the July-September period, down from $16.6 million in the same period a year earlier but up slightly from $6.8 million in the second quarter.

After paying $5.5 million to the U.S. Treasury as a preferred dividend on the $400 million in government capital it received last November, City National earned 5 cents a share available to common shareholders. That was down 85% from 34 cents a share in the third quarter of 2008.

Analysts’ expectations for the earnings had ranged widely, averaging 8 cents a share. The results were announced after the markets closed. Earlier, City National shares rose $1.64, or 4.1%, to $41.54 on a day of big gains for financial shares in general.

City National Chief Executive Russell Goldsmith has been saying since May, when the bank raised $100 million in capital by selling new shares to investors, that he wants to repay the government and shed the bank’s association with the federal bailout program. The bank raised an additional $180 million through a debt offering in the third quarter.

Asked today about repaying the funds from the government’s Troubled Asset Relief Program, Goldsmith answered only vaguely in an afternoon call with analysts.

"The process is continuing to evolve," Goldsmith said. "We look forward to repaying TARP in the future."

The CEO reminded the analysts that City National's capital is stronger than that of many rivals and that it avoided the worst mistakes of the bubble years, such as subprime-mortgage-linked investments and loans for major hotels and office buildings.

That eventually will help restore the bank's "fundamental earnings power" as the economy stabilizes,  he said. 

As for the present, "We managed to remain modestly profitable ... amid the worst economic recession in 75 years," Goldsmith said.

City National said its assets had risen to a record $18 billion and its deposits stood at an all-time high of $14.8 billion, up 24% from a year earlier -- a vote of confidence, as Goldsmith put it, from both new clients and existing customers who beefed up their deposits.

The bank set aside $85 million to cover credit losses during the quarter and wrote off $76.9 million in loans as uncollectible, raising its total allowance for loan losses slightly to $265 million.

City National said that as of Sept. 30, it had classified $452 million in assets as nonperforming, a category including loans on which payments aren't being made and foreclosed real estate. That represented 3.7% of its total loans and foreclosed property, compared with just 1.25% in the nonperforming category a year earlier.

In normal economic times, healthy banks are expected to keep their ratio of nonperformers under 1%.

-- E. Scott Reckard

Photo: City National CEO Russell Goldsmith. Credit: Lawrence K. Ho / Los Angeles Times

 

Wal-Mart, Wells Fargo trip stock market bulls

Wall Street's biggest ongoing worries -- the consumer and the banking system -- bubbled back up Wednesday, thwarting the stock market's march to new one-year highs.

It shouldn’t be news that retailers are expecting a difficult holiday season, but Wal-Mart Stores' warning to that effect was enough to spook some investors.

Wal-Mart slumped $1.07, or 2.1%, to $50.63 -- helping to fuel selling in the market overall in the last two hours of trading -- after a company executive cautioned about holiday expectations at an investor conference.

John Fleming, chief merchandising officer, said that consumers’ wallets "are challenged," and that the holiday season "is going to be tough, it is going to be late," according to Bloomberg News.

And as if to underscore the point, Wal-Mart announced a new round of price cuts, initially centered on groceries. (It probably wasn't a coincidence that Safeway Inc.'s shares fell 96 cents, or 4.1%, to $22.25.)

Investors seemed to ignore Wal-Mart CEO Mike Duke’s comments at the same conference that "no retail competitor . . . can deliver the kind of growth that Wal-Mart can over the next several years."

Wal-Mart isn’t acting like a growth stock this year: The shares are down 9.7% year to date and have mostly traded between $47 and $52 a share since early April. The Standard & Poor’s 500 index, by contrast, is up 19.7% this year.

Wal-Mart’s slide helped drag the S&P 500 down 9.66 points, or 0.9%, to 1,081.40, erasing an early rally that drove the index as high as 1,101.36 -- a new 52-week high. The Dow industrials fell below 10,000, losing 92.12 points, or 0.9%, to 9,949.36.

Losses in retail stocks were followed by heavier selling of financial stocks in the final hour of trading, after oft-quoted bank analyst Dick Bove at Rochdale Securities downgraded Wells Fargo & Co. stock to "sell" from "neutral," citing concern over the bank’s third-quarter earnings report.

Wells’ profit of $3.2 billion, or 56 cents a share, beat expectations, but Bove noted that the bank earned a stunning $3.6 billion from a hedging strategy related to its mortgage-servicing rights -- a gain that may be difficult or impossible to repeat. At the same time, problem loans "rose in every category despite the fact that the loan portfolio is shrinking," Bove wrote.

"It does not appear that the bank can sustain the third quarter’s results," he wrote.

Wells’ shares slid $1.56, or 5.1%, to $28.90. The stock is down 2% year to date.

-- Tom Petruno

Photo: Inside a Wal-Mart store. Credit: Joe Raedle / Getty Images

Third-quarter estimates: So far, 79% of companies have beaten them, firm says

The stock market rallied in recent weeks on the expectation that corporate earnings would top analyst estimates. So far, they’re doing more than that.

Led by the likes of Caterpillar Inc. and Apple Inc., 79% of companies have beaten analysts’ third-quarter estimates -- a record level if it holds up, according to research firm Thomson Reuters.

Historically, slightly more than three in five companies have beaten estimates, according to Thomson Reuters, which has tracked the data since 1994. The record -- set in the first quarter of 2004 and equaled in the second quarter of this year -- is 73%.

The 79% number is likely to decline as more companies report results, said John Butters, director of U.S. earnings research at Thomson Reuters. Only 95 companies in the Standard & Poor’s 500 index have reported so far.

Another measure of earnings is also encouraging. Aggregate earnings thus far have come in 19% above estimates, another potential record if its holds above the high-water mark of 13.6% notched in the second quarter.

Of course, any discussion of third-quarter earnings is extremely relative.

Third-quarter operating earnings overall still are expected to fall sharply -- down 21.5% compared with a year earlier, according to Thomson Reuters. That would be a record nine straight quarters of declining year-over-year profits. Overall growth is projected to resume in the fourth quarter.

And a major reason for the earnings surprises at companies such as Caterpillar and Yahoo Inc., which reported better-than-expected results after the close of the market today, is substantial layoffs.

Still, improving earnings are critical if the stock market is going to sustain its upward climb, and the comments emerging from some companies are encouraging.

Heavy-equipment maker Caterpillar bulldozed estimates this morning by reporting third-quarter earnings of 64 cents a share. Analysts had expected 5 cents. The company's stock gained $1.76 to $59.61, its highest close in more than a year.

The Peoria, Ill.-based company also bullishly pronounced that it saw “encouraging signs that indicate a recovery may be underway.”

-- Walter Hamilton

Bank of America posts net loss of $1 billion

Bank of America Corp. reminded investors this morning how ugly conditions remain in some parts of the U.S. banking industry.

The nation’s largest bank reported a third-quarter net loss of $1 billion, mainly because of the continuing travails of U.S. consumers. In a measure of its plight, BofA became the only major financial institution to miss analysts’ third-quarter estimates.

BofA lost 26 cents a share after paying out $1.2 billion in dividends, including $893 million to the U.S. government. Analysts had expected a 12-cent loss. BofA earned $1.2 billion, or 15 cents a share, a year earlier.

On a slightly positive note, losses in its consumer businesses rose at a slower rate than earlier this year, the company said.

"Obviously, credit costs remain high, and that is our major financial challenge going forward,” BofA Chief Executive Kenneth Lewis said in a statement.

After rising sixfold from their March low, BofA’s shares sank more than 4% this morning and are off almost 7% in the last two days.

BofA’s woes contributed to a sell-off in the stock market that dragged the Dow Jones industrial average below 10,000. As of 8 a.m. PDT, the Dow was off about 100 points. General Electric Co. shares sagged 5.5% after its third-quarter profit fell 45% and revenue was less than analyst expected.

BofA’s poor results extend what already is a turbulent time for the company.

Lewis agreed to forgo his salary and bonus this year at the behest of the Treasury Department’s pay czar. In an unusual move, he’s returning about $1 million that he had been paid this year.

-- Walter Hamilton

Why the market doesn't fall: The big money needs a winner in '09

After a seven-month rally the stock market ought to have plenty of excuses to pull back, or to at least stop rising for a while. Yet the Dow Jones industrials were back above 10,000 on Wednesday for the first time in a year.

Frustrated bears -- who believe that rebounding stock prices are way ahead of economic reality -- may be overlooking one basic reason why the market is holding up so well: Big money managers badly want this year to finish out a winner after the devastation of 2008. And a winner is what they've got working, if something doesn't come along to screw it up.

So with the economic and corporate-earnings data in recent months generally pointing to things getting slowly better instead of worse, many money managers have simply been reluctant to sell -- which is why the few market setbacks since June have failed to snowball beyond mid-single-digit percentage losses in major indexes.

The fear is that if you sell you'll be left behind. That's exactly what has happened to many or most investors who have let go of stocks in the last seven months, with share prices up 50% or more.

Now, as trader Dave Rovelli at brokerage Canaccord Adams put it, "Whenever we get any significant selling, the bids pile in." That further reinforces the idea that it's too early to exit the market.

"People are interpreting everything positively," said Doug Kass, head of hedge fund Seabreeze Partners. He thinks the optimists are wrong, and that stocks are headed lower.

But positive interpretation of the economic and profit backdrop is what happens in (and drives) a bull market. Investors look for an excuse to hold on, if not to buy. And the market's failure to accommodate calls for a sharp "correction" in prices brings more antsy money in from the sidelines. It helps the bulls' cause that cash now earns nothing.

I've lost track of the number of money managers who've told me that they believe the market can easily rally into the end of the year. Some element of that is wishful thinking, but it can become self-fulfilling.

Most big investors, however, also see a reckoning in 2010. Many expect the economy to struggle to stay in recovery mode next year. There also is universal concern about the federal budget deficit, a potential new wave of home foreclosures, and the risk of inflation if the Federal Reserve doesn't begin to tighten monetary policy.

But if optimism extends only to the end of 2009, the logical question is: When do portfolio managers start taking some money off the table, anticipating a rougher ride for the market in 2010?

They can't all just wait until New Year's Eve. Yet for now, many fund managers' retort to advice to lighten up on stocks is this: "You go first."

-- Tom Petruno

Photo: The Wall Street bull statue in lower Manhattan. Credit: Andrew Harrer / Bloomberg News

 

Dow Jones average approaches 10,000

Will the Dow Jones industrial average finally get back above 10,000 today?

The banking and technology sectors are doing their best to see that it does.

The Dow pushed to within nine points of 10,000 thanks to blockbuster earnings this morning from JPMorgan Chase & Co., and better-than-expected profits from Intel Corp. after the market closed Tuesday.

As of 8:30 a.m. PDT, the Dow was up 115.86 points, or 1.2%, to 9,986.92. JPMorgan shares were up 3.6% and Bank of America Corp. had gained 2.8%.

Intel was up 3%, with Hewlett-Packard Co. and Cisco Systems Inc. rising more than 2%.

A spate of generally strong earnings reports is helping the market extend its seven-month upward ramble. After sputtering two weeks ago in the face of troublesome employment data, the Dow and other major indexes have regained their footing amid enthusiasm over earnings.

JPMorgan blew past earnings estimates with third-quarter profit of $3.6 billion, or 82 cents a share. Analysts had expected 51 cents a share.

But given that JPMorgan has a sizable presence in both investment banking and commercial banking, its results also underscore the notably contrasting fortunes of Wall Street and Main Street.

Its results were driven by strength in fixed-income issuance and investment banking activities such as giving merger advice. That’s adding up to lush paydays for bankers and traders at JPMorgan and other Wall Street stalwarts, such as Goldman Sachs Group, which is expected to uncork blowout earnings Thursday.

On the other hand, JPMorgan earmarked $2 billion to cover expected consumer loan losses. That’s another reminder of how ordinary Americans are struggling to pay their bills in a stolid economy with rising joblessness.

-- Walter Hamilton