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Why Caution Still Feels Right

The averages hit post-Sept. 11 highs, but all the reasons for worry still exist.
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SAN FRANCISCO -- While investors are understandably focused on "event risk," it seems the possibility of


news has almost been forgotten. Today served as a reminder that good things can still happen in the world, and that stocks can respond in kind.


yesterday's performance, perhaps stocks would have risen today anyway. But news that the Northern Alliance entered the Afghanistan capital of Kabul, and some positive (or, at least, non-negative) earnings and/or forecasts from

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certainly provided a boost to investors' confidence.

Those developments proved more than adequate to overcome a profit warning from


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, and helped push major averages to their highest levels since Sept. 11.


Dow Jones Industrial Average

rose 2.1% to 9750.95, its highest close since Sept. 6. The

S&P 500

gained 1.9% to 1139.09, its best finish since Aug. 29. The

Nasdaq Composite

, already well above preattack levels, gained 2.8% to 1892.69, its best close since Aug. 27.

GuruVision: True Confessions

Watching the market begin its rally this morning, I wondered:

Are journalists too cynical?

I'm thinking about myself of course. I've written repeatedly about the possibility for a

faster-than-expected economic recovery and how the

demise of the 30-year bond provides an underpinning for higher equity prices.

But overall, this column's message recently has been one of

long-term caution vs. short-term optimism. To wit, when I wrote on

Oct. 18 that the "era of big government is back" and "the government is going overboard to foster an economic rebound," I fretted about the potential long-term inflationary pressures that could result, not the short-to-intermediate-term benefits.

The column's viewpoint hasn't been as bearish as some readers seem to believe, but clearly it wasn't as bullish as recent market action would have justified.

But predicting the market is not my job -- as is the case for traders, strategists and (some) economists. So the following is intended as an explanation rather than a

mea culpa


Underscoring the cautiousness is the fact that ever since the market topped in early 2000, hordes of would-be gurus have rushed to declare that the final "bottom" is in place and a new bull market has begun. And every time, to date, they have been proven wrong, as John Roque, senior analyst at Arnhold & S. Bleichroeder and

contributor, is fond of noting.

Like Roque, many of the most recently prescient market watchers -- those who are paid to call the market, that is -- remain skeptical that the current market rally will prove durable.

"What we think this rally looks and feels like is the strong positive market move in spring 2001," wrote Douglas Cliggott, market strategist at J.P. Morgan. "And just as that rally faded, and prices eventually broke down to new lows, we think this one will too."

Expectations last spring that earnings had bottomed and that growth would resume in the second half of 2001 proved specious, Cliggott recalled. He believes the same fate will befall current hopes about third-quarter earnings being the nadir.

Given expectations for a continued contraction in nominal GDP this quarter and the first quarter of 2002, the strategist said "it is very likely that earnings will come in lower -- and maybe a lot lower" in both those quarters vs. third-quarter results. "And if we are right on the earnings outlook, then we think we will be talking about a new intraday low on the S&P 500 on or about March 21, 2002," Cliggott concluded in a piece called "D¿j¿ Vu."

With the latest mad dash to new issues and tech stocks helping the Nasdaq rally now 33% off its Sept. 21 closing lows, many market watchers are having similar visions, including


Helene Meisler.

Elsewhere, Richard Bernstein, chief quantitative strategist at Merrill Lynch asked: "Are we crazy ... again?"

"The market continues to be priced like a growth stock, with little room left for disappointment," he wrote. "Some have suggested that it is impossible to predict the outcome of this war, or whether there will be another terrorist attack. If that lack of probability is true, we think it argues for lower multiples and not higher ones."

Bernstein's piece, published yesterday morning, was probably written before either the crash of American Airlines Flight 587 or the military breakthrough in Afghanistan.

Regardless, the S&P 500's price-to-earnings ratio is 20.7 based on 2000's actual earnings, 25.9 based on expected 2001 profits, according to Thomson Financial/First Call, and 22.5 based on 2002's forecasts, which isn't cheap or traditionally indicative of a bear market bottom. Also, many observers -- Cliggott, among many others -- believe the earnings expectations are too optimistic, meaning valuations are really stretched further still.

Count Thomas McManus, equity portfolio strategist at Banc of America Securities, among those many others.

Citing "indications of ongoing economic weakness," McManus yesterday cut his estimates for S&P 500 operating earnings to $10.95 from $11.20 for the fourth quarter and to $49.50 from $50.50 for 2002.

In conjunction, his rolling 12-month price target on the S&P 500 was lowered to 1200 from 1225, and his recommended equity weighting reduced to 60% from 65%. He raised bonds to 35% from 30% previously, recommending the fixed-income quotient be split evenly among Treasury inflation adjusted securities, corporate bonds and traditional Treasuries.


late September, McManus lifted his recommended allocation by 5% to 65%, "based on improved valuations and evidence of widespread caution," as he recalled yesterday. "These attractions have been erased by the intervening rally; today the market seems vulnerable to a retest -- at least -- of the September lows."

Certainly some will argue that widespread expectations of a retest make it less likely to occur; the proverbial "wall of worry" that markets like to climb. Among them, Don Hays of Hays Advisory, who remains bullish but whose latest thoughts will be updated in a future column.

Still, it's hard to argue the overriding sentiment among investors is one of bearishness or even caution -- especially after today.