Does the stock market's recent plunge represent a "buying opportunity?"
You can bet that before long market gurus will come out of their bunkers and start advising clients that buying the "right" stocks would be smart now that equity prices are substantially lower than they were two weeks ago. The gurus will remind investors that stock prices rose for nearly two years after the October 1987 crash. They'll say: "Do you want to be left out of the next big rally?"
But this isn't 1987. The U.S. economy -- even before oil prices began to increase sharply after Iraq invaded Kuwait -- is much weaker than it was in 1987. And, perhaps more important, consumers who have recently been battered by the falling value of their real estate holdings won't be able to shake off a plunge in the net worth of their stock portfolios as easily as they did in 1987.
"The economy is substantially slower than it was in 1987, and the prospects for growth are small," said Richard Rippe, chief economist for Dean Witter Reynolds Inc.. He said that this was true even before the Iraqi invasion.
Rippe said that in early 1987 the economy was improving, and that it was being given a boost because the declining dollar was making U.S. products more attractive around the world. "There was a stimulus coming that more than offset the feared wealth effect of the stock market drop."
The "wealth effect," described simply, is how wealthy Americans feel. In 1987, the experts were worried that the drop in stock prices would scare Americans so much that they would cut back on their purchases and send the U.S. economy into a recession.
But others pointed out at that time -- correctly it turned out -- that most Americans didn't measure their financial well-being by how stocks were doing. With the job market still strong and real estate still booming, Americans in 1987 were easily able to shrug off the stock market crash.
This time around, of course, Americans aren't feeling quite as comfortable. Not only is unemployment rising, but the speculative bubble in real estate has popped in many parts of the nation.
The consumer, said Albert Sindlinger, who has surveyed Americans daily for the past 30 years, "was booming in 1987. He was doing great." Now, said Sindlinger, the consumer is frustrated and cutting back on spending.
Still, there are several good reasons stock market gurus will start preaching the gospel of the "buying opportunity." For one thing, many Wall Street experts have been predicting that stock prices were heading higher. It would be embarrassing for them to suddenly reverse direction. Predicting that newly priced stocks represent a "buying opportunity" gives these experts a convenient way station on their way to more pessimistic predictions.
There is also great opportunity for market predictors right now. Someone who is telling clients that a "buying opportunity" exists will be a hero if stock prices improve. There is little reward for a market prognosticator who starts predicting lower prices once stocks have begun to move down.
Traders say stock prices could rally if the situation in the Middle East cools off. In fact, stocks could actually enjoy a substantial -- albeit temporary -- improvement if inflation fears are eased by some solution to the crisis.
Even if stocks do rally, experts warn that it will not change the fact that the U.S. economy is slowing in a hurry. The sharp increase in the nation's unemployment rate last month to 5.5 percent from 5.2 percent had nothing to do with the rising price of oil. Those folks lost their jobs because the economy isn't doing well.
On the surface, stock prices didn't look too expensive before they recently started declining. But if looked at another way, prices could be comparable to what they were before the 1987 crash.
As of last week, the 500 stocks that are included in the Standard & Poor's 500 index were selling at a price-to-earnings ratio of around 13-to-1. That means stock prices for these 500 shares were 13 times higher than the earnings per share that are being predicted by S&P. That's a pretty moderate level. In contrast, those ratios were up to nearly 20 to 1 just before the crash in 1987.
But the typical recession could trim corporate profits by 20 percent. If that happens, stocks at today's prices would be selling at about a 16 to 1 ratio. In order for a 20 to 1 price-to-earnings ratio to be reached, corporate profits would have to decline by a hefty 35 percent.
Experts say a drop in corporate profits of that magnitude is unlikely even in a recession. But nobody really knows what impact the rising price of fuel will have on companies. Is this a "buying opportunity?" Some experts might say it's a good time to say "bye-bye" to stocks.
John Crudele is a columnist for the New York Post.