It Only Looked Like Capitulation

SAN FRANCISCO -- Since trading was halted in the wake of the tragic events of Sept. 11, many market watchers have predicted that a tradeable rally could arrive at any moment. At about 2:40 p.m. EDT today, that moment appeared to have arrived.

After trading as low as 8480.21, the Dow Jones Industrial Average recovered to close off 1.6% to 8759.13. The S&P 500 ended down 1.6% to 1016.10 after trading below 1000 for the first time since mid-October 1998. After trading as low as 1451.31 and threatening its first close below 1500 since Oct. 9, 1998, the Nasdaq Composite ended down 1.8% to 1527.80.

On the surface, today's session appeared to fit the bill of the capitulation session so many market watchers have suggested is necessary to signal the end of the bear market. But John Roque, senior analyst at Arnhold & S. Bleichroeder (and RealMoney.com contributor), whose market calls this year have been stellar, believes otherwise.

"The comeback is tremendous, but I wouldn't think" today marked the capitulation bottom, Roque said shortly before the closing bell. "I don't want to sound like a Cassandra, but so far everyone [who's been looking for a bottom] has been wrong. It may be that this one is right, but I don't think so."

At 2.2 billion shares on the NYSE and 2.4 billion shares in Nasdaq trading, volume was heavy but not sufficient to qualify as a so-called washout session, Roque said. Furthermore, down volume was heavy but not overwhelming, besting up volume by 3 to 1 on the Big Board and a little more than 2 to 1 in over-the-counter trading.

Days like today "continue to draw people in," Roque fretted, suggesting a session in which stocks close at their lows is more likely to signal capitulation, rather than ones like today that rekindle optimism.

There's also the argument that with so many participants still looking for, and calling, the bottom, it's likely to remain elusive.

Contrary to what some readers might think, I take no pleasure in writing that and hope I'm proved wrong. But I don't believe hopeful commentary or flag-waving can change the reality of what is happening on Wall Street.

That said, I thought it might be helpful to examine some of the reasons why any bounce from what almost everyone agrees are technically "oversold" levels may prove disappointing. Yes, today's turnaround was impressive, but don't confuse that with an up day.

First, stocks -- or stock averages -- might be oversold but can get extremely oversold before bouncing. Recall the market was considered wildly overbought by many observers in late 1999, and it kept right on rising (for a few more months, at least).

Second, the news flow continues to undermine any rally attempt. Today's financial headlines included profit warnings from Eastman Kodak (EK) and Adobe Systems (ADBE), as well as huge layoffs at Boeing (BA). Meanwhile, a heavy day of sell-side activity was highlighted by Credit Suisse First Boston downgrading recommendations on a host of media and software names, and Deutsche Bank Alex. Brown downgrading a slew of oil service firms.

Amid growing concerns about the U.S. economy, the Federal Reserve's Beige Book survey showed economic activity was "sluggish" in August and deteriorating in some regions in early September, prior to the terrorist attacks on Sept. 11.

On the political front, Pakistani President Pervez Musharraf pledged to support the U.S.' hunt for Osama bin Laden. But, reflecting the political reality of his situation, Musharraf also said he did not want Afghanistan's Taliban government to be harmed. He also said Pakistan's chief concerns are the "safety of our country from any external threat, our own prestige and the safety of nuclear missiles."

The comments about external threats combined with a warning to India about painting Pakistan in a negative light raised the specter of military action between the longtime adversaries, which contributed to the market's midday misery.

Further ratcheting up expectations for military action, President Bush reiterated warnings that the campaign against terrorism will be a long one, Attorney General John Ashcroft said the terrorists likely received help from foreign governments.

But fears of a widening conflict notwithstanding, reports that more than 100 U.S. warplanes are being mobilized in the Persian Gulf appeared to provide some impetus for the market's late-day recovery.

However, "beyond the ominous clouds of war, one can certainly sense that the veneer of patriotism is beginning to slip under concerns that there is selling and everyone wearing a red, white and blue stickpin may not be holding up their end of the bargain," Charles Payne, president of Wall Street Strategies, wrote midday. "It was institutional selling on Black Monday [in October 1987] that contributed more to the damage than selling from the retail customer. Now the retail investor is wondering if the big boys are bailing."

That's precisely the point I was trying to make in my column yesterday.

Rethinking the Risks

A third major reason any rally may yet prove fleeting is "the vicious attacks on the World Trade Center and the Pentagon have given rise to force-majeure risk in U.S. assets," previously only typical of investments in lesser developed countries, as Ashraf Laidi, chief currency analyst at MG Financial Group commented today. Force-majeure risk refers to "acts of God" such as natural disasters, but "also encompasses risks to national security and political stability," he continued. "Most notable about last week's tragedy is its multi-faceted threat on national, social, economic and psychological stability. Such threats have become all too real to a society that deemed itself immune."

In less dramatic terms, after 18 months of declining prices, it could be argued that most investors who wanted to sell already had done so. Those who weren't selling, or were buying, were betting on an economic and market recovery sooner, rather than later. Those so inclined pointed to a smattering of improvement in leading economic indicators as evidence that, while heady times might not be afoot, the worst had passed, a view this column expressed sympathy with.

But after the events of Sept. 11, many of those investors are now forced to re-examine such expectations.

Laidi, who previously had been fairly optimistic about the greenback, said today that the reassessment of risks here "could even neutralize any safe-haven dollar flows that normally occur from signs of instability" elsewhere in the world. Intraday, the dollar traded at a 20-month low vs. the Swiss franc, approached a six-month low vs. the euro and regurgitated overnight gains vs. the Japanese yen; the greenback recovered sharply in tandem with the stock market, ending mixed vs. other major currencies.

Short-dated Treasury securities, gold and gold stocks continued to be among the few areas of interest for buyers. The yield on the two-year Treasury note fell to 2.82% today, while the Philadelphia Stock Exchange Gold & Silver Index rose 0.4%.

Meanwhile, investors who've previously been pessimistic about stocks don't yet feel compelled to change that view. That day is coming, but probably isn't here yet.

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