Antsy Investors May Be Drawing Lines in the Sand

Some investors have finally decided to take a few chips off the table.

The tremendous stock market rally that began in mid-January appears to be running into its most serious resistance yet. The Dow Jones industrial average on Tuesday was on its way to its biggest percentage decline since Jan. 9 before a late rally clipped the loss to 0.9% for the day.

More important, the broad market was considerably weaker for a second consecutive session. The Nasdaq composite index, at 1,798.71 on Tuesday, now is off 3.1% from its all-time high last Friday.

And some of the hottest stocks of this year’s rally--including Lucent Technologies, Dell Computer and Yahoo--are in the process of sharp pullbacks. Lucent is down 14% from its recent peak.

So what? some investors may well ask. Tech stocks like those are always volatile. What’s more, the hallmark of this long bull market, including this year’s surge, has been “rotation, not liquidation”--meaning that investors have tended to rotate money from one stock sector to another, never pulling out of the market entirely.

The problem now, some Wall Streeters say, is that so many sectors have been pumped up in this year’s rally that there are few relative bargain sectors to rotate into. “We’ve rotated through all the sectors and there’s nothing left,” argues Hugh Johnson, veteran analyst at First Albany Corp. in New York.

That may be an exaggeration, but it’s worth remembering that the only weak mutual fund sectors in the first quarter were natural resources and real estate. The technology, health-care, utility, communications and financial services sectors, among others, all have enjoyed big gains this year.

Technical analysts, who watch the market’s day-to-day inner workings for clues to its near-term trend, don’t like what they see. With the Dow hitting a new high Monday while most stocks fell, the market is showing “all sorts of non-confirmations and divergences,” says Ralph Bloch, a market technician at Raymond James & Associates in St. Petersburg, Fla.

“History suggests that this type of split relationship doesn’t last for long,” he says. “Either Nasdaq and the techs start to rally nicely, or the Dow starts to lose momentum and then heads south.”

Dennis Jarrett, head of technical analysis firm Jarrett Investment Research in Westport, Conn., believes that “something changed [for the market] around the first of the month. The enthusiastic buying evaporated” in the broad market, he said, even as the blue-chip Dow continued to surge.

Could this pause be related to worries about what are widely expected to be weak first-quarter earnings reports for blue-chip companies overall? If the market is supposed to anticipate, it shouldn’t just now be waking up to the unhappy juxtaposition of high stock prices and weak earnings--the latter owed to the convergence of Asia’s economic mess, rising wage rates in a tight U.S. labor market and a severe lack of product pricing power.

But Edward Kerschner, investment strategist at PaineWebber in New York, notes that in the summer of 1996, stocks suffered a steep pullback even though investors shouldn’t have been surprised by that year’s disappointing second-quarter earnings reports. “The market ignored the expectation of weak earnings until earnings actually were reported,” he points out.

What about all that money out there--the wave of liquidity (courtesy of world central bankers’ relatively easy money policies) that keeps pushing into stocks, for lack of better places to go?

“Liquidity flows don’t care about this quarter’s earnings or next quarter’s earnings,” argues Richard Bernstein, market analyst at Merrill Lynch & Co. in New York. In other words, as long as money is flowing--and has no better destination--it ought to keep flowing into financial assets like stocks.

That’s still the long-term bullish case to make for stocks. But we also know that markets don’t go in straight lines, up or down. People get nervous, and “corrections” happen. What technicians see now is a tired market that wants to take a break. Kerschner and Jarrett figure the Dow might drop as much as 5% from its peak, which would mean about 450 Dow points. Johnson thinks a 5% to 8% pullback would be healthy, but he adds that even that modest a decline may be asking too much.

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Early Warning?

Some of the leaders of this year’s stock market rally--including key technology and telecom issues--have pulled back sharply in recent sessions.

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1998 Tues. Pct. Stock high close chng. Lucent Technologies $77.38 $66.19 -15% Parametric Tech. 34.88 29.50 -15% Dell Computer 71.94 63.13 -12% Unisys 20.19 17.75 -12% Yahoo Inc. 105.75 93.25 -12% Electronic Arts 47.75 42.38 -11% FileNet 50.63 45.63 -10% Cadence Design 38.25 34.88 -9% GTE Corp. 64.38 60.56 -6% Microsoft Corp. 93.06 87.25 -6% S&P; 500 1,122.70 1,109.55 -1%

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Source: Times research

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Tom Petruno can be reached at tom.petruno@latimes.com