SAN FRANCISCO -- For the second consecutive week, broader averages packed up their troubles in their old kit bag and smiled, smiled, smiled while blue-chips lagged. The troubles included a potentially disappointing quarter-point rate cut by the
, intermittent trading glitches, and another round of warnings, most notably from
For the week, the
Dow Jones Industrial Average
fell 1% and the
was down fractionally, while the
gained 6.2% and the
rose 4.9%. (The Comp's week included a bizarre extra hour, as
trading was extended Friday to make up for earlier system outages.)
The week provided a microcosm for the just-completed second quarter, during which major equity averages ended higher for the quarter. Despite concerns about the economy and expectations that earnings will be the
weakest since 1991, the Dow rose 6.3% in the quarter, the S&P gained 5.5%, the Comp rose 17.4% and the Russell 2000 climbed 13.8%.
Still, major averages remain down year to date: the Dow by 2.6%, the S&P by 7.1% and the Comp by 12%. However, the Russell 2000 is up 6% year to date, reflecting the ongoing outperformance of small- and mid-cap stocks.
The market's recent gains reflect expectations that Fed rate cuts will revive the economy and that major averages bottomed in late March/early April -- expectations that are not mutually exclusive.
Court of Appeals for the District of Columbia
overturning a ruling to break up Microsoft also provided a psycological boost, and shares of the software giant rose 1.5% for the week.
Hope on the economic front arrived this week in the form of stronger-than-expected reports on durable goods and consumer confidence, as well as continued evidence of a strong housing market. On Friday, the
University of Michigan
reported a second consecutive rise in its monthly index of consumer confidence, while the
Chicago Purchasing Managers
report bested expectations.
Also Friday, first-quarter
growth was lowered to a scant 1.2% from 1.3% in the
"final" revision. Nevertheless, the aforementioned data and the Fed's
decision Wednesday to lower rates by 25 basis points vs. 50 (or more) contributed to rising hopes that the economy is on the mend.
Such sentiment benefited equities this week but bonds faltered. Fixed-income securities generally fare better in periods of economic weakness because they are most sensitive to inflation. Inflation fears have receded as energy prices have dipped and the dollar has remained strong. But some fixed-income participants still fret over inflationary pressures in the pipeline.
Bonds also were hurt this week by rising concerns about the durability of the budget surplus. With the economy slowing, some bond investors fret that tax receipts will decline just ahead of forthcoming tax cuts. Additionally, given the balance of power in Washington, any spending submitted by the White House, say on defense, is likely to be met by other quid pro quo spending requests by congressional
For the week, yields on the benchmark 10-year Treasury (which move in the opposite direction of its price) rose 16 basis points. For the quarter, they rose 48 basis points. Yields on the two-year note, which most closely track the fed funds rate, rose three basis points for the week and six basis points for the quarter.
Bonds also suffered because of the renewed interest in equities as some investors switched from bonds to stocks.
Quarter by Quarter
Action this past week and quarter have reinvigorated some investors' hopes, although it'll be interesting to see whether the situation Friday on Nasdaq damages confidence. Even before the snafu, skepticism remained a mainstay on Wall Street.
"I think we came through the market and economic declines in good shape, in the sense things could have been worse," said Stanley Nabi, managing director at
Credit Suisse Asset Management
said of the quarter. "Having said that, I think during the last few months the market rebound has set another problem for us -- one of valuation."
estimates, the S&P 500 is trading with a price-to-earnings ratio of about 22 times reported 2000 earnings, 23 times expected 2001 results, and 20.5 times expected 2002 results. While down from peak P/E levels of early 2000, that is not cheap by historic standards. "Old Economy stocks are no longer cheap," Nabi said, declaring that the "valuation disparity" created during the tech-stock bubble has largely been closed.
"The market is trading at very high levels relative to anticipation of a recovery next year
and this will restrain stock prices from making a major move in next six to 12 months," he continued, predicting earnings will continue to deteriorate at least through the third quarter. Nabi also believes consensus expectations for S&P earnings of $53.12 this year and $59.77 in 2002 are too optimistic. He's using $49 for this year and $54 for next.
"I don't see how some leading strategists can postulate a 20% increase
in earnings next year," he said. "It just isn't going to come about" because the economic recovery will be slow, the consumer is tapped out and foreign economies are weakening.
Having said that, Nabi is not predicting disaster and believes major averages have seen their lows. It's just that "there is very little room on the upside for stocks" based on current valuations, he said, calling small-cap value the "only particularly cheap sector."
Nabi, who manages about $4 billion in value funds for Credit Suisse Asset Management, cited
as examples of small-cap stocks that are attractive on a valuation basis. His firm is long each of the aforementioned.
The other group he remains bullish on is energy, despite recent woes, which he predicts will likely last through the summer. On a cash-flow basis, "energy is the cheapest major sector in the market by far," the veteran market player said. "Come the fall, you'll probably see oil prices stabilize not far below recent levels, which will be very good for companies to produce solid earnings."
Value investors will start returning to the group as those fundamentals unfold, Nabi said, declaring an intent to add to existing positions in anticipation. He recommended starting with service stocks that have been battered most in recent weeks, including
Transocean Sedco Forex
Helmerich & Payne
Aaron L. Task writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to
Aaron L. Task.