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As stocks swirl like ticker-tape confetti on a windy day, the chill of twilight on Wall Street is increasingly palpable. Share prices aren't down much yet, just 7% from their mid-July highs. And the Dow Jones Industrial Average is actually still up for the year, by around 3.5%. Yet investors can't shake the sense that something is wrong -- desperately, stealthily, strangely wrong.
One reason for the disconnect between the feeling of a real problem and the appearance of no problem is mundane: The way that the major market indexes are designed, the Dow($INDU) and Standard & Poor's ($INX) can remain buoyant when less than 10% of their constituent stocks are rising.
Yet at present, the disparity is actually worse than that, as market breadth -- the difference between the number of all stocks that are rising versus the number that are falling -- has fallen off a cliff in recent weeks. After a four-year bull market in which investors allocated more and more of their money to the shares of small and medium-sized companies, this narrowing of the market has hit many individual accounts like a fall from a 20-story building.
It doesn't do you much good to know that the Dow is enduring a modest correction if you're down 23% on a popular stock like XM Satellite Radio (XMSR, news, msgs), 50% on printer maker Lexmark International (LXK, news, msgs) or 77% on homebuilder Beazer Homes USA (BZH, news, msgs).
To make sense of this condition, which is beginning to look like a slow-motion crash, I've turned to five analysts and observers who have provided a lot of great advice to readers over the past decade. I'll start with the most bearish and work my way toward optimism.
P, as in pessimism
Let's start with Mr. P, a veteran East Coast hedge-fund research director who has anonymously offered brilliant guidance here from time to time since 2000 -- most famously when he recommended going heavily long the market two weeks after the Sept. 11, 2001, terror attacks, and also for a recommendation to buy steel stocks in 2004.Today, Mr. P wants investors to know that credit crises like the one afflicting the markets now are like slow-moving brush fires that persist for long stretches despite repeated efforts to knock them down. He believes that although Bear Stearns (BSC, news, msgs) is already down 32% this year over its losses in mortgage-backed securities and affiliated hedge funds, it could suffer much more damage over the rest of the year as customers and counterparties lose confidence in its ability to fulfill its obligations.
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He reminds us that Enron was not actually felled by fraud, although in the fullness of time we learned that there was plenty of illegal activity there. It was knocked down when it admitted it could not accurately value many of its assets, failed to find counterparties with which to trade and lost its lines of credit. Through the first quarter, Bear was reportedly the prime broker to about a fifth of the world's $1.5 trillion in hedge funds. If a material number of those funds take their business elsewhere due to a lack of confidence in Bear's ability to mark its assets appropriately and find liquidity -- and there's little doubt the exodus has already begun -- then the company's condition could spiral downward quickly.
Steel is backMr. P further notes that hedge funds that received redemption notices in July and August have until Sept. 30 to raise money to return to customers. A rush in September to sell stocks and bonds could get out of control, precipitating crashlike conditions, he warns. If selling does explode, he thinks the Federal Reserve will step in to cut rates by as much as 100 basis points in a short period of time, launching a swift snap-back stock rally and crushing the dollar in a repeat of the 1998 reaction to the central bank's bailout of beaten-up debt and emerging-market investors.
Continued: Wait for a real rally
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