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Bearly There

Does the mini bull run mean the market’s finally turned the corner? Or have investors, weary of being weary, just decided to be irrationally optimistic? A reality check for bear hunters.


Eight weeks ago, the stock market seemed on the verge of crashing. The NASDAQ, down 80 percent from its high, looked like it was about to break back below 1,000, a level it hadn’t seen in years. Stalwarts like Cisco and Intel sunk to or flirted with single digits. Telecommunications, semiconductors, wireless, personal computers—all seemed to be not just slowing down but actually imploding. JPMorgan Chase, once the most prestigious bank on earth, seemed on the verge of failing. Scandals dominated not just the business pages but the front pages. Year three of this devastating bear market looked like the most damaging of all.

And then, almost miraculously, the stock market exploded in one of the greatest rallies in history—complete with a pre-holiday money-basting that gave investors a truly happy Thanksgiving. Hundreds of stocks have doubled; dozens have tripled or quadrupled. We haven't seen a white-collar perp walk since the rally began. Technology, which led the market down from its March 2000 highs, couldn’t be hotter, with the nasdaq soaring 32 percent from its summer bottom.

And suddenly, everyone on Wall Street who still has a job is wondering, Is this a new bull market? Has the raving Kodiak that chewed the longhorns into little pieces these past three years finally taken a spear to the jugular?

The answer, unfortunately, is no. The market’s not going to roar back to new highs anytime soon. In fact, much of the move has occurred already. But I don’t think we will revisit those lows, either, because the economy, after deteriorating for three straight years, has at last stabilized. And amazingly, there is a move afoot in Washington that is going to make stocks far more attractive compared with every other asset class—a move to change the taxation of dividends.

What does it mean for you as you try to figure out whether the stock market’s worth your attention, or whether you are better off plowing more money into your home or your bank account?

First, let me explain what I mean when I say the economy has stabilized. Yeah, we’re still in the same slow-growth environment that has victimized virtually every American company during this horrid period. But there is a difference: Now some firms have realized that things aren’t getting better, and have adjusted their workforces and their strategies in order to take share from weaker, more vulnerable competitors.

In technology, for example, a streamlined IBM has managed to take share from EDS in software and EMC and Sun Micro in hardware. It’s zero-sum. I wouldn’t touch the losers, but IBM could rally 30 points and still be dirt-cheap. Similarly, in wireless, Nokia has simply crushed Motorola and Ericsson. If we get even nominal growth in wireless, Nokia could have a huge 2003. In telecommunications, the winner is Verizon, with a better balance sheet and stronger cash flow than any of its competitors, including BellSouth, SBC, Sprint, AT&T, and, of course, WorldCon. In equipment, it’s Cisco over Lucent and Nortel. Every major industry now has tons of losers, as has been the case for the past three years, but we now have some winners as well. These winners, big, well-known companies, have been responsible for much of the fall’s drive to higher ground.

But just as important, if we are to get to where we can break out of the range that has capped every move up, is the domino effect that the midterm elections might end up creating. For as long as the Democrats controlled the Senate, the Republicans struggled, mostly in vain, to create breaks for shareholders. Now, with the GOP in control, the president is on the verge of proposing a change in the tax code that would allow individuals to avoid paying taxes on some portion of their dividends. If we get dividend-tax relief, there could be a rush into those equities that generate a yield north of 2.5 percent, a level many of the stocks in the Dow Jones Industrial Average currently deliver.

And why not? Right now, since the last Federal Reserve interest-rate cut, cash yields about 1.25 percent and you have to pay taxes on it. With any change in dividends, individuals can be expected to flock to these higher-yielding equities.

But a change in the dividend law would do more than just boost the stocks that give off a solid yield. It would also aid an area of the market that’s been leveled by the scandals and the regulators as well as the declines in mergers, acquisitions, and trading: the brokerage houses. Individuals know that dividends don’t lie. Companies don’t pay dividends out of phantom cash; most of the scandal-ridden companies didn’t pay dividends. Look for 2003 to be the year when the individual comes back to the market, searching for stocks that offer yield protection and some capital gains.

It’s one reason why I just bought the stock of Charles Schwab, the company that has the most to gain from the change in the tax code (because dividend-tax relief will matter most to Schwab’s middle-class clientele). It’s also a reason why I can no longer be negative on JPMorgan—its $1.36 dividend seems secure, and owning JPMorgan, the second-highest-yielding stock in the Dow, will become a popular option among those seeking yield.

Unfortunately, America’s favorite investment pastime—riding technology stocks over cliffs and into oblivion—won’t benefit much from this change; most don’t pay dividends, and very few of them have any cash to pay out anyway. But the biggest—Microsoft, Cisco, and Intel—have oodles of cash that they’ve been reluctant to part with because dividends get taxed at the corporate level, too. If some of the more pro-growth members of the president’s entourage can encourage changing the law so that dividends get treated like interest paid—in other words, deducted from taxable income—then you could see big returns for all three of the big boys.

Will we ever return to the days of nasdaq 5,000 and Dow 12,000? Without a tax-code change, those gains seem highly unlikely. But nasdaq 1,000 and Dow Jones 7,200, where we sunk just two months ago, now seem unlikely to be revisited unless some exogenous event occurs on the order of 9/11.

If I had to bet—and I do with my personal account—I’d bet that the market will mark time until the Iraq situation clarifies itself. If we move into Iraq, look initially for a decline that still doesn’t exceed those we saw at the beginning of October, and then, if the war goes well, a resumption of the advance that we saw this fall.

And if we get the big tax-code changes I am looking for, any Iraq-related decline will be a gift, a fantastic opportunity to buy simply because things aren’t as bad as they used to be just eight short weeks ago.


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