Stock Market Headed Lower, but No Crash

The stock market is headed moderately lower this summer, but you can expect the worst of it to occur by no later than August.

I am projecting a 10 percent drop in the Dow Industrials over that time and a 12 percent decline in the S&P 500 Index. The actual price targets are 9406 for the Dow, which currently stands at 10500; and 1275 for the S&Ps, now at 1450.

If my forecasts prove correct it would leave the Dow Average 20 percent below January's all-time high of 11750 and the S&Ps 18 percent beneath March's record 1553.

Such a selloff would be mild in comparison with the steep summer decline of 1998, which lopped 21 percent from the value of both averages in just six weeks.

My predictions are based solely on the charts, the simplest way I know of to make objective sense of a fundamental picture that is presently very confusing and greatly stressed by concurrent bullish and bearish influences.

If you want to handicap the averages yourself, here are some of the things that I believe will constrain the market from moving either to record highs or to scary lows over the foreseeable future. First the bullish factors:

• The Fed is unlikely to continue tightening credit aggressively, since there are signs the economy is beginning to cool. Consumer confidence dropped last week to its lowest level since November, and this suggests America's buying fever may moderate in the months ahead.
   
• Corporate borrowing rates have begun to ease following an upward surge in recent months. This will help reduce pressure on business profit margins.
   
• A healthy and growing cynicism on Wall Street has helped to deflate share prices of some of the most egregiously over-hyped gas-bags, particularly in the high-tech sector. The result is that the "irrational exuberance" that Fed chief Alan Greenspan fretted about a while back is nowhere in sight. Indeed, many of the yesterday's hottest stocks have been pounded so hard that even bears may view them as bargains. From record highs to recent lows, Qualcomm has fallen 70 percent, Microsoft 50 percent, Cisco 39 percent, Amazon 71 percent, eBay 62 percent and Yahoo! 57 percent.
   
• The trillions of dollars worth of stock that Baby Boomers stand to inherit is still mostly in the steady hands of their parents. My own informal survey of wealthy retirees suggests they will not dump their portfolios if stocks enter a period of prolonged stagnation or moderate weakness.
   
• The recovery of East Asian economies continues to pick up steam, providing a strong market for our exports. Year-over-year GDP growth is up 13 percent in South Korea, 12 percent in Malaysia and 7 percent in Thailand. Elsewhere, Mexico's economy has been growing at a robust 8 percent clip, and the only disappointments among the emerging economies are Brazil and Indonesia, where growth has been around 3 percent.
   
• Finally, odds are growing that Americans will get a substantial across-the-board tax cut next year, regardless of who is in the White House. President Clinton so far has resisted the idea, calling Republican presidential contender George W. Bush's proposal to cut top marginal rates from 39.6 percent to 33 percent "irresponsible." But that was before last week, when estimates of the ten-year budget surplus made as recently as February were raised by $1.3 trillion, to $4.2 trillion. With projections swelling so spectacularly, Al Gore will be under mounting pressure to match Bush's give-back. When he finally capitulates, it will be good news for Wall Street.
   

Now for a few reasons why equity averages are unlikely to hit new highs any time soon:

• Short-term interest rates have already risen enough to dampen the economy, and although the effects have yet to work their way through the system, a slowdown lies ahead in spending for retail goods and housing. It is not high interest rates per se that will cool the housing market, but rather the growing perception that home prices will not be appreciating as rapidly as before. The speculative fever has broken most visibly in Silicon Valley, along with a broader IPO-mania that has given so many buyers the wherewithal to pay absurd prices for homes.
   
• $2-a-gallon gas is sludge in the gears of the economy, and its burdensome effect on the confidence and spending habits of consumers will continue to mount.
   
• April's steep decline in share prices was so swift and punitive that many investors will be more strongly inclined to take profits on rallies. The effect will be most pronounced among those corporate insiders who saw easy riches in the form of stock options slip suddenly from their grasp.
   
• Consumer spending must retrench from last year's astounding peak, a record 84 percent of GDP. This is considerably above the 66 percent level that has prevailed through most of the last decade and well nigh unsustainable. The rapid swelling of equity values that made it possible without savings has stalled, with Dow Industrial shares trading almost exactly where they were a year ago.
   

A wild card which greatly outweighs any combination of the above is the value of the dollar, whose relentless strength over the last decade has nourished the bull market in stocks while simultaneously creating a credit bubble that must someday be unwound.

My hunch is that the inevitable downturn of the greenback for the long-term will unsettle the stock market, which in turn will drive the dollar lower.

This downward spiral is all but unavoidable although, for the time being, a relatively steady stock market will continue to deflect attention from the by-now pathological excesses of global credit markets.

Be warned, however, that if the stock market's decline significantly exceeds my forecast over the next few months, and if the dollar comes down with it, it will be a long, long way to the bottom.