October's Optimism Goes Unpunished

Analysts who predicted a liquidity bubble in <I>TSC's</I> Oct. 5 story are looking prescient.
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In early October,


examined the possibility that the stock market could rally because of the amount of cash in the banking system, among other factors. About two months and 18 percentage points in the Nasdaq later, the speculation is looking sound.


Oct. 5, the market was in the early stages of what would become a breathtaking recovery from its post-attack lows, although there was no way to know it at the time. Experts noted the initial moves had bullish characteristics; stock investors seemed suddenly inclined to look for needles of good news in haystacks of bad. That trait has been the hallmark of the rebound.

Since the story ran, the

Dow has risen 8%, while the

Nasdaq has advanced 18%. The

S&P 500 is up 6%. All three are above their Sept. 10 levels.

Nor has the


relented in its role as the market's ally. It eased for the tenth time this year in early November, bringing rates to their lowest levels since 1961. M3, a measure of money supply, is up 1.3% in October and growing at its fastest rate in decades. And there is still about $5 trillion in money market funds, savings accounts and CDs.

"With money market fund returns below the rate of inflation, there is pressure to go back into the equity market," said Richard Dickson, a technical analyst at Hilliard Lyons. "There's a legitimate argument to be made that the liquidity from the Fed is making its way back into stocks."

Back on Top

Tech shares have led the bounceback, a trend not predicted by any of the strategists in the first story. Since Oct. 5, the PhiladelphiaStock Exchange Semiconductor Index is up 30%, while the American Stock Exchange Networking Index is also sharply higher. That has Dickson, among other analysts, concerned. "I'd feel better about this rally if it were based on defensive stocks," he said. "Tech stocks are going up on the same thing that drove them higher in 2000 -- wishful thinking."


(INTC) - Get Report

has moved up 39.5% since Oct. 5.

Advanced Micro Devices

(AMD) - Get Report

has gained 59%. And even

Applied Materials

(AMAT) - Get Report

, which missedfourth-quarter earnings estimates on Nov. 15, is ahead 24%.

In many cases, technology names are trading at a premium to the market. "Even at these depressed levels, stocks are trading at high multiples," said Dickson. Based on 2001 earnings,

Juniper Networks

(JNPR) - Get Report

trades at aprice-to-earnings multiple of 48. Using 2002 earnings, it has a P/E of 57.

Since Oct. 5, Juniper Networks has gained 70%,


(CIEN) - Get Report

has advanced55%,

JDS Uniphase


has climbed 68%, and

Nortel Networks


has risen 46%.

On Nov. 12, Ciena projected fourth-quarter earnings would slightly exceed Wall Street estimates, lifting its stock 9.6% that day. But at the same time, the company said it would cut its workforce by 10%. Back in early October, Nortel said it would report a larger-than-expected third-quarter loss.

"Professional investors found themselves behind the market," said Jon Brorson, director of equities at Northern Trust. "So they looked to technology to goose their portfolios, even if they didn't believe in the fundamentals." It has paid off. If you bought

Sycamore Networks


on Oct. 5, you would have scored a 10% profit the next day. The stock is up 58% since then.

Risk Curve

One gauge of speculative activity in the market continues to suggest investors are risk averse. Margin debt in September was $144.7 billion, downfrom $278 billion in March 2000. "Having experienced the burst of the bubble in 2000 and the shock of Sept. 11, most investors are more aware of the riskof holding stocks," said Tony Crescenzi, bond market strategist at Miller Tabak.

Nevertheless, the charge on loans to brokers on stock exchange collateral -- or call money -- has been decreasing rapidly over the past few months, falling from 4.25% in mid-October to 3.75% today. Interest on margin accounts, which is tied to call money, has been dropping as well. That's likely to encourage more investors to get back into the market, if it hasn't already.

Brokerages have reported heavier traffic in recent weeks. "Trading volume seems to be linked to the overall direction of the market," said MikeDunn, a spokesman for Datek Online. His firm has reported average daily trade volume in November of 80,000, up from 77,000 in October.

Dispersion Players

The stock market has also benefited from a shift in asset allocation from bonds to stocks. In the October story,


noted that a number of hedge funds had been piling up cash on wagers that the yield curve -- the spread between short-duration bonds and long-duration bonds -- would steepen as interest rates came down. But the Treasury Department's decision on

Oct. 31 to eliminate the 30-year bond subverted those bets. As a result, observers say, money has flowed back into stocks.

"Since the Treasury's announcement, the yield curve has been flattening," said Holly Liss, chief technical strategist at Fuji Futures. "It's come downfurther with reduced expectations for additional Fed easings." As for stocks, investors who were testing the water are getting back in more confidently: "The consumer," Liss says, "is starting to feel better about the economy."

Whether the latest upward swing is a reasonable bet on a turnaround in the economy is a matter of debate on Wall Street. "The generaldrift of the market makes sense," said Christopher Low, chief economist at First Tennessee Capital Markets. "Companies have been cutting costs sincethe fourth-quarter of last year; we've just seen the second largest inventory liquidation, as a percentage of gross domestic product, since World War II; and the Fed is cutting interest rates."

Technicians say the market is a discounting mechanism that's coming back from oversold levels. Even with the recent market gains, the Dow JonesIndustrial Average is still down 9.3% for the year, while the Nasdaq Composite is off 30%. "You don't get two speculative bubbles within a year or two of each other," said Richard McCabe, a technical analyst at Merrill Lynch.