What a Week: One of the Worst Ever

SAN FRANCISCO -- Proving that the old saw "the market hates uncertainty" has teeth, stocks tumbled this week in the face of myriad unknowns in the wake of the Sept. 11 terrorist attacks.

For the week, the Dow Jones Industrial Average lost 14.2%, its fifth-worst weekly percentage decline in history and the biggest in the post-World War II era. The S&P 500 shed 11.6%, and the Nasdaq Composite declined 16%, its worst weekly performance since April 2000.

All the Averages Take a Plunge After the WTC tragedy, there was a huge gap-down for Monday's open

Technical analysts are now eyeing the lows of October 1998 -- 7400 for the Dow, 923 for the S&P and 1357 for the Comp -- as the next major areas of support.

The week began with hopes that patriotic investing or simple bargain hunting would stem the market's decline. But while the return of trading was remarkably efficient, such sentiments were soon overwhelmed by anxiety about the economy, and layoff announcements and/or profit warnings by almost the entire airline industry, as well as corporate giants American Express (AXP Quote), Boeing (BA Quote), Honeywell (HON Quote), Eastman Kodak (EK Quote), Chubb (CB Quote) and Dow Chemical (DOW Quote).

By week's end, concerns about the economy were matched by worries about geopolitical developments.

Thursday evening, President Bush expressed America's steadfast determination to use "every resource at our command" to defeat terrorism. The President's ultimatum to Afghanistan's Taliban was met with defiance and with continued anti-American protests in Pakistan and elsewhere.

On Wednesday, news that American warplanes were heading to the Persian Gulf was cited as a catalyst for the market's late-day bounce, which dramatically pared that session's losses. But the heightened prospects for a war that is expected to be long and difficult proved no salve for investors on Friday. After a midmorning bounce proved fleeting, the Dow finished down 1.7%, while the S&P lost 1.9% and the Nasdaq shed 3.3%.

Worry, Worry Everywhere

The Conference Board reported Friday that 47% of Americans believe the tragedies of Sept. 11 will trigger a recession. The percentage seems much higher on Wall Street; on Friday, Merrill Lynch joined the growing legion of firms forecasting recession.

Morgan Stanley economist Richard Berner, among the first to warn of recession late last year, expressed heightened concerns this week: "Beyond the human tragedy of last week's terrorist attacks, I'm worried that they mark the beginning of a new, less favorable era for the U.S. economy and financial markets," he wrote.

Since the tragedies of Sept. 11, Congress has approved $40 billion in emergency spending and is voting on another $15 billion for the beleaguered airline industry, while the Federal Reserve eased short-term rates by another 50 basis points and added more than $300 billion in temporary, short-term liquidity into the financial system. As I wrote last Friday, some believe such action -- in addition to stimuli already in place -- could help the economy recover sooner than many now contemplate.

Brett Gallagher, who oversees management of $3.5 billion as head of U.S. equities at Julius Baer Asset Management, believes the events of Sept. 11 will accelerate what was already preordained -- a downturn in consumer confidence and spending, more Fed rate cuts, and the lowering of consensus earning estimates pushing down equities.

But the government's response "also means we'll plant the seeds to get us out [of recession], and we may come out sooner," he said.

But while "sharp cyclical downturns are typically followed by vigorous cyclical upswings," Berner believes a V-shaped recovery will remain elusive "until the supply shock from the added costs and increased risks of doing business dissipates." Equity markets are still "coming to grips with both a cyclical decline in earnings and the uncertain prospect for a recovery to normal," he added.

Notably, Gallagher said midweek he doesn't expect to be getting more aggressive until the first quarter of 2002, given his expectation that the economy won't produce "tangible signs of improvement" until the middle of next year.

Indeed, fears that a protracted war will bring about a global recession were widespread this week: Japan's Nikkei 225 fell to a 17-year low on Friday, while bourses in London, Germany, Italy and Switzerland fell to their lowest levels since 1997.

Investors' desire for perceived safe havens was evident in the buying of Swiss francs, which reached a 21-month high vs. the dollar; in U.S. Treasury securities, which reversed a weeklong slide on Friday; and in gold stocks, which rallied even as the metal struggled to break above key resistance at $293 an ounce. The Philadelphia Stock Exchange Gold & Silver Index rose 4.8% this week.

Contrarian and Other Indicators

For the six trading days ended Sept. 19, a record $66.4 billion went into money market funds while $5.9 billion came out of equity funds, according to AMGData.com.

Despite the mutual fund industry's declarations to the contrary, the inflow/outflow data provides "clear evidence of redemptions," according to Thomas McManus, equity portfolio strategist at Banc of America Securities.

The strategist cited the redemption activity -- the fourth consecutive week thereof -- as one sign of investor capitulation in his recommendation to increase equity allocation to 65% from 60% on Friday, reducing bonds to 30% from 35% and leaving cash at 5%.

"While we doubt we have seen the ultimate bottom for the broad market averages, U.S. stocks are down enough for us to begin to put more of our capital at risk," McManus wrote.

Advocates of contrarian investing could find numerous positive signals this week, including that McManus, who has been "defensively positioned" for more than a year, turned more optimistic. Conversely, longtime bulls such as Abby Cohen of Goldman Sachs and Jeffery Applegate of Lehman Brothers cut earnings estimates and price targets.

Other signs of distress included the forced selling of 135 million shares of Disney (DIS Quote) by the Bass family on Thursday; the Chicago Options Exchange Volatility Index trading as high as 57.31 on Friday and above 40 for the final three days of the week; and the percentage of bearish newsletter writers rising to 37.6% from 36.5%, while bulls fell to 35.7% from 39.6% in the latest Investors Intelligence survey.

A Long Time Since a Week This Bad The week's carnage sparked memories of the '30s

On Friday, new 52-week lows on the New York Stock Exchange bested new highs 770 to 19 and by 807 to 18 in over-the-counter trading. The NYSE saw three of its five heaviest trading days in history, further evidence that it was a week of extremes, both emotional and financial.

As I commented in a RealMoney.com face-off, putting money into the stock market makes more sense now vs. a week ago. Given the steep declines that have occurred, it's increasingly likely a rally will be vigorous when it arrives.

But short- and intermediate-term prospects for stocks remain dicey, as the economy and the market still face tremendous obstacles and ever-rising uncertainty.