Latest sell-off signals worse recession than expected

By WILL DEENER / Special Contributor

Night, it seems, has descended upon the stock market.

Emotional despair among investors has pushed the Dow Jones industrial average down to levels not seen in more than a decade. This old warhorse of stock indexes breached the psychological barrier of 7,000 on Monday as it fell 299 points, or about 4 percent.

The index of 30 blue-chip stocks hasn't traded this low since May 1997. For disillusioned investors, such a technical barrier is far less significant than the real losses they have suffered.

Millions of average investors have lost about half of the value of their stock holdings as the Dow has plummeted from its all-time high of 14,164 in October 2007 to its Monday close of 6,763. The bear market has now wiped out some $10.4 trillion in stock market value.

"The number 7,000 is not what is important," said Hugh Johnson, chairman of Illington Advisors in Albany, N.Y. "What is important to everyone is the message that the market is sending us with these losses."

And that message is that the current recession probably will be longer and more severe than most people expected. For months, the consensus on Wall Street was that the low of 7,500 that the Dow hit in November 2008 would mark the bear market bottom.

Many market analysts predicted that while the Dow would "retest" that low, it would not break through it. They were wrong. The scary thing now is where the Dow and the broader Standard & Poor's 500 index will make their next stand.

"If we don't hold at around this level, I could see the Dow at 5,000," said Howard Simons, a market strategist at Bianco Research, a market research firm.

"I certainly believe we have further to go down."

Similarly, many experts thought the S&P 500 would hold at 750, but it recently breached that level and closed at 700 on Monday. Now, they worry that the next stop for the index could be 500.

"This is just terribly, terribly disturbing," said Johnson, who is typically one of the more optimistic analysts.

Monday's sell-off was triggered by the staggering $61.7 billion quarterly loss at insurer American International Group Inc. This was the largest quarterly loss ever recorded by a U.S. corporation.

On the taxpayers

The government has tried to prop up the ailing company, and that leaves taxpayers on the hook for some $163 billion. Simons said this latest announcement just reminds investors that the nation's financial system and economy are in shambles and taxpayers are going to have to pony up the money to stabilize things.

"But so far the actions taken by the government have not done much to correct the problems," Simons said.

In a recent interview, John Bogle, founder of the $68 billion Vanguard 500 index fund, predicted that the recession may last until 2011.

With this almost daily deluge of bad economic news, stock investors seem to have just given up.

"Abandoned hope is one of the scariest things I see," Simons said. "But this is America, and we don't give up, so we'll eventually get through this."

Unpredictable earnings

Obviously, investors would like to know whether we are getting close to a market bottom. The problem with forecasting a bottom is that it depends on assumptions about corporate earnings, stock dividends and the value of companies. In the current environment, these assumptions "are not worth the paper they are written on," said Johnson of Illington Advisors.

For example, the 2009 earnings-per-share estimate for the companies in the S&P 500 is $62.20. That figure is only 12 percent below last year's estimate. Simons and other analysts believe that earnings estimate is much too high, given the losses that are expected in corporate America this year.

"I mean, come on. All the banks are losing money, and many other companies are losing massive amounts of money," Simons said. "I would think a more realistic number would be $50 a share."

Earnings are, of course, the mother's milk of stock prices. So while it may seem that stocks are "cheap" now given how much the market has dropped, many investors just don't believe the estimates, and they are not buying stocks with any enthusiasm, he said.

"I just don't think people believe they can make any money in the stock market now," Simons said. "Cash is king for now."

Ironically, it is just this kind of investor "capitulation" that typically marks the end of bear markets, said James Stack, a market strategist at InvesTech Research.

"Capitulation occurs when investors ultimately decide to abandon the stock market in lieu of safer alternatives," Stack said. "It is often accompanied by panic selling and steep declines on high volume."

A positive outlook?

That's why he and some other money managers are starting to turn slightly more positive on the market. There is a chance this could be one of the best buying opportunities in years, but it is still much too early to know, he said.

Johnson agreed, saying those who say stocks are cheap at these levels "may be basing that opinion on shaky assumptions."

Further, investors should always remember that the stock market is a leading economic indicator. In other words, it telegraphs where the economy might be in six to nine months.

"And right now, the stock market is sending a very gloomy, yet clear message," Johnson said. "And that is that the outlook for the economy in 2009 and 2010 will be much worse than people expected."