Bad News Is Good News, Unless It’s Your News

It’s heartening to know that some traditions survive on Wall Street. For example, the idea that bad news for the economy is good news for financial markets.

That wonderful tradition began sometime in the mid-1980s, and carried us through much of the 1990s. Weak economy? Excellent, Wall Street repeatedly declared. Because that meant the Federal Reserve was sure to be cutting interest rates, or at least leaving them alone.

For the stock market, there’s no obsession like the obsession with the Fed--as investors proved again on Friday, when news that the economy lost 116,000 private-sector jobs in May, the biggest such decline in nine years, sent stocks soaring.

The technology-dominated Nasdaq composite index rocketed 6.4% on Friday and a record 19% for the week, to end at 3,813.38. That cut the bear-market loss from the index’s March 10 record high to 24.5%, versus 37.3% at its closing low of 3,164.55 on May 23.

For the broader market, the rally last week put the average U.S. stock mutual fund back in the black year to date. As of Friday, the average fund was up 3.9% from Dec. 31, according to Morningstar Inc.

The sick joke for much of the early-to-mid-1990s was that Wall Street loved a big corporate layoff announcement more than almost any other news. As for the poor folks on the end of the pink slips--well, hey, if they just owned some stock, they wouldn’t feel so bad, the market’s bulls generously proffered.

But can the market really get a lot more mileage, in the near term, out of expectations for an economic slowdown?

Certainly, the idea that the Fed, after six interest rate hikes since last June, might finally be getting what it wants--a weaker economy--offers hope that rates aren’t headed much higher.

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But it’s obviously dangerous to underestimate Chairman Alan Greenspan and friends. In the last credit-tightening cycle, which began in 1994, the Fed raised rates seven times. The last increase in that cycle was a half-point boost in the benchmark federal funds rate, to 6%, on Feb. 1, 1995.

That turned out to be the final increase of that cycle. But it surprised many analysts, who noted at the time that there were already signs that the U.S. economy was slowing.

What’s more, the Fed’s series of rate increases in 1994 had helped precipitate a crash in many smaller foreign stock markets, the Orange County investment-portfolio debacle, and, in part, the Mexican peso’s collapse.

But none of that deterred the Fed from raising its key rate again at its first meeting of 1995. This is a central bank that likes to get the job done.

And if getting the job done indeed means a much weaker economy lies ahead, it’s not at all clear the stock market will remain as ebullient as it was last week--especially if there are no signs the Fed will get back into rate-cutting mode any time soon.

In 1995, the Fed was cutting rates again by July of that year. This time around, there’s a presidential election looming. Though it’s a myth that the Fed doesn’t alter rates near elections--it cut rates in July and September of 1992, for example, as the economy struggled--it may take a significantly weaker economy to shift the Fed into that mind-set this summer.

Many investors no doubt will be happy enough to buy stocks, or at least stay with what they have, if they believe the Fed is simply done tightening credit. That’s a rational approach for a true long-term investor.

But last week, even amid growing hopes that the Fed might be finished, victims of the economic slowdown so far found there were relatively few investors interested in their stocks.

Bad news is good news? Ask National RV Holdings how it feels about that. The Perris, Calif.-based maker of motor homes saw its shares fall to $9.25 by Friday, the lowest since 1997, after the company said its shipments in April and May were down 30% from a year ago.

Shares of auto giant DaimlerChrysler have slumped 20% since April 10 on fears that its sales were weakening, which is exactly what has been happening. The company last week announced a massive new sales-incentive program to try and rev up business.

Meanwhile, paper and lumber company Boise Cascade has seen its stock crumble in recent weeks, ending at $29.13 on Friday, close to the 52-week low.

Late Friday, Boise announced that it will cut back production at several of its Western sawmills in June and July because “market conditions have significantly deteriorated” over the last five weeks, as demand has ebbed with the slowing housing market.

To be sure, bargain hunters have been sniffing around in many other industry sectors--enough so that the blue-chip Standard & Poor’s 500 index is just a 3.4% move from setting a new all-time high.

Bank stocks were red-hot last week, lifting Bank of America, for example, from $54.63 a week ago to $61 by Friday. If you think interest rates are peaking, bank stocks are the classic play on lower rates.

That is, unless banks’ loan portfolios are about to blow up because too many of their corporate and consumer borrowers are already overstretched--and will soon find, in a weaker economy where credit is tighter, that they can’t make loan payments.

The point is, there are many good reasons why the stock market shouldn’t head back to the moon in the near term. Too many questions still loom, not only about the Fed’s intentions, but about the extent of the damage so far to the economy. Note that, in a week or so we may begin to get the first “pre-announcements” of second-quarter earnings from companies that don’t expect to meet analysts’ estimates.

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That Nasdaq could post a record percentage increase last week shouldn’t surprise anyone. This is a market in which once-shocking volatility has become the norm.

The interesting question is whether, after the spectacular surge of the last five years, the stock market in general could become a place where a lot of action happens on a weekly or monthly basis, but not much progress is made for the next year or more.

The accompanying chart shows trading in Southland-based clothing retailer Wet Seal (ticker symbol: WTSLA) since the mid-90s. This is a chain that has done a better job than many serving the fashion whims of young female shoppers. Sales and profit were on a nice upward track for most of the late-1990s.

But the stock still swung wildly, reacting terribly to the slightest disappointment from the company, only to resurge relatively quickly. It has been, arguably, a trader’s dream--but a lousy investment for buy-and-holders.

Is that an extreme version of Wall Street’s near-term fate?

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Tom Petruno can be reached by e-mail at [email protected].

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Is Wet Seal the Market’s Future?

Shares of Southland-based specialty retailer Wet Seal have been a trader’s delight over the last four years, swinging wildly on company news--or as investors bet what the next big news might be. But the stock has been a terrible disappointment to long-term investors. Monthly closes and latest on Nasdaq:

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Friday: $12.00

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Source: Bloomberg News

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For Chrysler, Bad News Is Just That

Technology stocks may be cheering the idea of an economic slowdown, but falling sales at DaimlerChrysler have left the automakers shares near their 52-week low. Weekly closes and latest on the New York Stock Exchange:

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Friday: $54.63

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Source: Bloomberg News