Stock Slide: Time to Buy on a Dip, or Sell?

Last week's stock stumble raises concern about a market that remains near record levels even as profits show signs of weakening.

More trouble may lie ahead, say some analysts, citing not only earnings but also other key indicators such as interest rates and investor sentiment.

Indeed, if a dip turns into a dive, a major uncertainty is whether small investors will hold or bail out of stock mutual funds.

Surveys suggest that the great majority of mutual fund and stock investors now adhere to a "buy and hold" approach, irrespective of daily market swings. Many draw a lesson from the market crash that occurred 10 years ago yesterday: The market can fall hard, but it doesn't stay down forever.

Buy-and-hold attitude

"These are retirement dollars," says one suburban New York nurse who invests in mutual funds. "They stay put."

Pondering the 200-point drop in the Dow Jones Industrial Average last week, she says, the stock market always eventually goes "back up."

The issue of investor attitudes is far from academic.

Recent turmoil in the market leads a number of analysts - although perhaps still a minority - to believe that a downturn is likely in the months ahead, perhaps already under way.

The extent of the downturn - whether it is a "correction" of 10 percent or a deeper "bear market," largely depends on the behavior of small investors, the analysts say.

"It's worrisome," says Prudential Securities analyst Hildegard Zagorski, referring to the market's pummeling last week.

Both large and small companies were hit, with the Dow closing the week at 7847.03. The Nasdaq Composite Index fell 32.78 points Friday to close at 1,666.88 points.

Factors propelling the market downward, says Ms. Zagorski, include disappointments about lower corporate earnings and fears of a new interest rate hike by Federal Reserve policymakers in November. Economic reports last week showed signs that the economy may be stronger than anticipated, raising concerns about inflation.

Last week's turmoil was "an earnings-driven event," says Jos Rasco, an economist at investment firm Hoenig & Co. in Rye Brook, N.Y.

While Mr. Rasco is not prepared to say that the market is entering a period of correction, he sees a high likelihood that it will.

"Historically, the market has not risen this dramatically very often." He counts only a handful of periods in the 20th century in which the market shot up over 29 percent. In each case, he says, the market corrected some time within the next 12 months.

Tech profits in question

Technology companies saw some of the hardest selling last week, including bellwethers such as computermaker Compaq and and chipmaker Intel.

In a sign of how touchy investors have become, even a 42 percent surge in earnings at Compaq was not enough to assuage concerns.

Mainstream consumer companies such as McDonald's were also battered by profit concerns.

Investor sentiment is another sign troubling some analysts. If everyone is bullish, it can signal a market ripe for a plunge. While current indicators are mixed, bullish sentiment is "getting up there," says Richard Dickson of Scott & Stringfellow in Richmond, Va.

One barometer of mood: Only 14 percent of investors were bearish two weeks ago. "On a historic basis, that's very, very low," Mr. Dickson says.

The market "is getting into very dangerous territory," says David Blitzer, chief economist at Standard & Poor's in New York. "It cannot go on forever like this." He cites both earnings concerns and a possibility rise in interest rates.

Mr. Blitzer, however, says that a pullback - which he expects to occur at some point in the months ahead - will probably be modest, around "5 percent to 10 percent."

What troubles him is that already-high stock prices may not go anywhere "for about a year, as happened to the market in 1994."

"Earnings growth is definitely slowing," says Rao Chalasani, chief investment strategist at Everen Securities, in Chicago. "Unless interest rates come down," which he deems unlikely, "the market will probably go through a consolidation" of about 10 percent.

Still, most analysts see continued gains for the stocks of small and midsize companies, as contrasted with the more-vulnerable blue-chips that many analysts see as particularly overpriced relative to their earnings prospects.

"Large caps have plateaued, but small and mid-cap stocks look attractive," says Peggy Farley, managing director of investment house AMAS Securities in New York.

Ms. Farley believes the Dow will hit 9000 some time in 1998, with no significant downturn in sight. But if it climbs faster, say hitting 10000 next year, "there could be a possible downturn," she says. "That would be a case of the market getting ahead of itself."

Advice From Both Sides of Fence

Bulls

1. Don't fight the ticker tape. Stocks have been on a long-term up trend since 1982. The investment cycle continues to favor stocks over other investments. Bond returns lag way behind stocks.

2. The economy promises to slow, easing concerns about inflation. Consumer spending, for example, is moderating.

3. Low inflation means interest rates remain low and could fall further, helping profits.

4. Corporate profits continue to rise, albeit at a slowing pace.

5. Mergers and IPOs (initial public offerings of stock) propel the market forward.

6. Baby boomers are shoring up the market through heavy investing in retirement plans.

7. Market "rotation" is under way from stocks of large companies to those of small and mid-size companies. That breadth, in contrast to a focus on only a few top companies, signals a healthy market.

Bears

1. Market euphoria - so many bulls running around - is a sign the market has topped. Bulls abound just before a downturn.

2. Some leading bulls are starting to hedge their bets. Example: Prudential Securities technical analyst Ralph Acampora, who sees the Dow hitting 10000 next summer, is preparing a report advising clients to shift to some alternative investments, reports The Wall Street Journal.

3. Stocks are priced highly, although not at record levels, relative to company earnings.

4. Foreign money is tightening, which could reduce a key source of funds in the US market.

5. The US labor market remains taut, which could boost inflation.

6. Market advances for the Dow and S&P 500, the bellwether indexes, are harder and harder to come by, or sustain.

7. If stocks begin a sharp decline, investors might panic and sell - deepening the trouble.

Weatherproofing Checklist

These steps can help shield your portfolios during a market downturn, experts say:

* Use asset allocation: Divide your assets in a mix that's comfortable for you among US stocks, foreign stocks, bonds, and cash.

* Know your investment time frame and tolerance for risk. Saving for retirement 30 years off, one person might choose to sell nothing in a downturn. The rationale: It's notoriously hard to "time" the market by jumping in and out. And the long-term trend should be up. But a more cautious person might move a sizeable chunk of money from stocks into cash or from "growth" stocks to stabler "value" stocks.

* Know which stocks could best ride out a market crash (analysts point to utilities and real estate) and which ones might fall especially hard (index mutual funds).

* Consider tax consequences. In a taxable account, selling stocks one month and buying them back another can be costly.

* Have telephone and account numbers for your investment house on hand.

* Maintain cash reserves of three to six months for emergency living expenses.