The icy winter storms that hit the Northeast at the end of January were nothing compared to the chill that settled on the trading floors, as all three major stock indexes fell in the first three weeks of the year. Never before have all three - the Dow Jones Industrial Average, Standard & Poor’s (S&P) 500, and Nasdaq - declined in the first three weeks of a new year. Analysts blamed rising oil prices and declining consumer confidence for the year’s bad start, with the more bearish observers adding that the economy and earnings are slowing down - and that stocks are overpriced.
Those who look to historical data to interpret current patterns expressed concern over this rocky start. Since 1897 (its first full year of operation), the Dow Jones Industrial Average has fallen in only 35 percent of all its years - however in those years when it was down for the first week, the risk of a decline for the entire year increased to 50 percent - a big increase over the average. If early January is an indicator of how the market will perform for the year, then 2005 definitely got off to a bad start. The bears also note that traditionally January is a time for optimism and that the year’s new influx of retirement money - via pension funds and IRAs - usually pushes the market up. If this is not happening, they suggest that something is amiss.
Of course, there are other more positive precedents to consider. Bullish commentators note that the biggest annual market losses have come in years when stocks rose in early January. This is an apparent contradiction, but it makes more sense when you consider that the biggest slumps come when contented investors are hit with unpleasant surprises.
For an individual investor, these are confusing times. For every bear citing gloom and doom, it seems there’s a bullish guru putting a positive spin on the same market news. Here are a few notable factors to ponder:
- The adage "a rising tide raises all boats" probably will not apply in 2005. In 2004 and the preceding year, earnings rose pretty much across the board. In 2005, analysts expect to see marked divergence between companies that continue to grow their earnings and those who do not.
- On the positive side, corporate cash flow and balances are high and companies appear willing to invest in increasing their productivity.
- Earnings growth for the S&P 500 is forecast at a 15.5 percent rate for the fourth quarter of 2004. Though this remains a very respectable rate (though down from the 16.8 percent logged in the third quarter), some analyst urge investors to note that energy companies are responsible for a disproportionate amount of this growth, and that earnings growth would be around 10 percent without their significant contribution. The impact of oil prices really comes home when you consider that energy companies represent only 28 of the 500 companies in the index.
- Oil prices are not the only factor. Wall Street gurus are eying gross domestic product (GDP) numbers closely, too. November’s reported trade deficit was higher than economists expected. Contrary to expectations that the declining dollar would give U.S. companies a more competitive edge overseas, lower export numbers and higher import tallies have caused GDP rates to decline. Bears now wonder how companies, that don’t seem able to capitalize upon a 28-percent depreciation in the trade-weighted dollar, would fare if the dollar stabilizes.
Perhaps, as many bulls believe, the pessimism that was a feature of the markets in 2004 has made investors overly cautious today. Nevertheless, oil prices remain a wild card, and the savvy investor will want to pay close attention to fundamentals - fourth quarter earnings reports and key economic indicators.