Stocks Plunge On First Day Of Third Quarter

July 1, 2002, 4:19 pm Eastern Time
By Allen Wan

NEW YORK (CBS.MW) - The Nasdaq plunged 4.1 percent Monday as the biotech and technology sectors got hammered on regulatory setbacks for a host of biotechnology names and on fallout from WorldCom's accounting scandal.


The Dow Jones Industrial Average, which had been hovering around the flat line for most of the day, fell 1.4 percent to 9,109, while the Nasdaq Composite sank 50 points to end at 1,406.

"I'm shellshocked." said Donald Selkin, director of equity research at Joseph Stevens. In explaining the late-day collapse, Selkin cited low volumes, few buyers and a continuation of recent losing patterns. "There is a disconnect between the market and a decent economic recovery," he said. "This is the first time we don't have a market that's up six months after an economic recovery."

Losses were across the board, but the biotech and Internet sectors took the cake, as their benchmark indexes fell more than 7 percent. Airlines, computer hardware and software, and chip stocks also posted huge losses.

Biotech stocks were hit hard by negative opinions from the Federal Trade Commission and the Food and Drug Administration about several companies. The only gainer was the defensive gold sector.

Earnings jitters had something to do with the tech weakness. Some analysts expect the pre-announcements to start this holiday-shortened week - the beginning of the third-quarter earnings season.

Besides lingering terrorism jitters as the FBI issued a vague warning about threats around the Independence Day holiday, investors had to contend with fallout from the WorldCom accounting scandal as regulators and even President Bush sounded off on corporate wrongdoing. On Monday, WorldCom plunged over 90 percent to pennies a share as investors unloaded the stock amid fears the company might have some more skeletons in its closet. Shares of the telecom giant were halted last week after the company announced that it had wrongly accounted for $3.8 billion in revenues. Volume topped over 1 billion shares.

But news on the economy continued to be generally good. The manufacturing sector grew for a fifth-straight month in June and exceeded economists' expectations. The ISM index rose to 56.2 percent from 55.7 percent in May, the highest reading since February 2000. Construction spending, however, fell 0.7 percent in May after a gain in April.

"The equity markets can only trade on today's negative headlines for so long before the reality of the solid economy holds sway. If we have a surprisingly strong payroll growth number on Friday, something I believe is quite possible, then sentiment in the equity and bond markets could shift dramatically," said Joel Naroff, president of Naroff Economic Advisers.

"Today's ISM report fortifies my belief that Friday could be a very interesting day, especially since everyone will be on vacation."

An aerospace merger dominated corporate headlines as Northrop Grumman finally snared rival TRW for $7.8 billion in a deal that will create the second-largest defense contractor in the country.

Shares of Northrop fell 4 percent while TRW shares rose 0.4 percent. Rivals Boeing fell 0.2 percent General Dynamics lost 0.3 percent.

The other highlight of the day came from industrial giant 3M, which expects higher-than-expected earnings in the second quarter on the back of strong sales growth, especially in Asia. Its shares were up 2.9 percent to $126.52.

Another winner was Tyco, which climbed 3.6 percent ahead of the pricing of its CIT financial services unit later this week. General Electric was flat.

Losses for biotech stocks were particularly noteworthy, with the benchmark index down 3.5 percent.

The top percentage losers on the Nasdaq were biotech firms Alkermes and Tripos.

Alkermes sank around 50 percent on news that a Johnson & Johnson unit received a non-approvable letter from the U.S. Food and Drug Administration for its risperidone long-acting injection drug. Risperidone uses Alkermes' Medisorb drug-delivery technology. Shares of Johnson & Johnson fell 2 percent.

Shares of Tripos tripped up after warning on its earnings, losing 46 percent.

Biotech compadres Digene and Cytyc were both down more than 3 percent after the two companies called off a planned merger after the FTC blocked the deal.

The drug sectors was down about 1.7 percent, dragged down by the likes of Pfizer, which fell 1.4 percent on a Los Angeles Times report that internal documents show the executives from unit Warner-Lambert masked early indications that the diabetes pill Rezulin was potentially dangerous from federal regulators.

Technology was wobbly, with computer software, hardware and Internet stocks looking the most vulnerable. Chip stocks fell despite data from a semiconductor trade group showing signs of a recovery in the semiconductor sector. Chip giant Intel was flat, however.

Other well-known technology names getting hammered included Cisco and Sun Microsystems, down 2.9 percent and 4 percent, respectively, in the most-active trade. Shares of Siebel plunged over 5 percent after Banc of America cut its estimates.

The telecom sector was soft, with AT&T and Qwest down 4.7 percent and 7.1 percent, respectively. Major losers in the Internet sector included AOL Time Warner, down 5.8 percent, and Yahoo, down 5.4 percent.

Merrill cuts S&P targets

Merrill Lynch's chief U.S. strategist Richard Bernstein lowered his 12-month target for the S&P 500 to 1050 from 1200, noting that indicators continue to suggest a 5 to 6 percent expected return is more appropriate than the 20 percent implied by the previous target.

The S&P 500 ended Friday at 989.

"Our Sell Side Indicator has begun to fall, but remains well into 'sell' territory. Observers now clearly realize the market's issues, but the hackneyed 'capitulation' is nowhere in sight according to this indicator," Bernstein said. The strategist also noted that cash has now outperformed the S&P 500 for the last 55 months.

The Nasdaq 100 Index shed 3.3 percent. The Russell 2000 Index of small-capitalization stocks fell 2.5 percent.

Decliners outpaced gainers 18 to 12 on the Dow and 23 to 11 on the Nasdaq. Volume was 957 million on the Dow and 1.14 billion on the Nasdaq. Volume on the Nasdaq did not include WorldCom's 1.2 billion shares, which are likely to be delisted after the July 4th holiday.

In overseas action, Tokyo stocks ended slightly lower despite a better-than-expected reading for the Tankan corporate sentiment survey, suggesting the worst is over for the Japanese economy.

In Europe, markets got a bounce from news that Jean-Marie Messier was ousted as the CEO of media giant Vivendi Universal. Vivendi's shares were up 19 percent in Europe.

Vivendi's U.S. shares rose 10 percent after Le Monde reported that Messier had resigned to take responsibility for the company's flagging stock price and rising debt load.

Bond prices fell on signs that stocks would gain ground Monday. The benchmark 10-year bond fell 6/32 to 100 14/32, yielding 4.82 percent, down 2 basis points. The 30-year government bond slipped 6/32 to yield 5.52 percent, up one basis point.

In the foreign exchange market, the dollar was a bit higher, gaining 0.3 percent to 119.85 yen, while the euro fell 0.1 percent to 99.02 cents after falling just short of parity earlier in the session at 99.72 cents.

"If financial markets are believed, the U.S. economy is in deep trouble. The equity market is near a five-year low, while bond yields have plunged," said Merrill Lynch Chief Economist Bruce Steinberg.

"Yet the U.S. economy has performed far better than anyone had anticipated six months ago and recent data have been positive. Either the markets are sniffing out problems that will soon show in the economic data ... or the economy will continue to grow, earnings will surge, and the markets will eventually reflect that reality. We believe in the latter scenario," he said in a note.

There will be plenty of data during the shortened Fourth-of-July week, which will see the stock exchanges shuttered on Thursday and close early -- at 1 p.m. ET -- on Friday.

Some of the most important economic releases of the month will hit the tape as investors daydream about barbecues and fireworks such as May factory orders and the June employment report.

End of terrible first half for investors

The end of the second quarter closed out a devastating first half of the year for investors, with more than $1.4 trillion in wealth wiped out and the S&P 500 turning in its worst performance in more than three decades.

The S&P's percentage losses for both the second quarter and first six months of 2002 were the steepest since 1970. It wasn't quite as bad for the Dow: the blue chip barometer's percentage loss in the first-half -- 7.8 percent -- was the shabbiest since 2000.

The Dow closed out the second quarter down 11.2 percent, the Nasdaq off 20.7 percent and the S&P 500 13.8 percent. On the week, the Dow fell 0.1 percent -- its sixth straight weekly loss -- while the Nasdaq rose 1.6 percent.

Using the Wilshire 5000 Index as the broadest gauge for the stock market, about $1.4 trillion in market value was wiped from stocks in the first half of the year as a falling dollar and a rash of massive accounting scandals shook investor confidence to its foundation. Now the trillion-dollar question: what will happen in the second half?

"Unless the entire corporate world has cooked the books and this is not just isolated to a relatively few aggressive companies, then we think the latest selling is probably overdone and that the worst is behind us," opined Mark Arbeter, chief technical analyst at Standard & Poor's MarketScope

But not everyone agrees, including Barry Hyman, chief investment strategist at Ehrenkrantz King Nussbaum.

"We can't say we reached an ultimate bottom. Accounting flaws may still be uncovered over the next one or two quarters," Hyman remarked.

Not surprisingly, the most crushing losses among S&P 500 stocks were among tech, telecom and energy trading firms: Dynegy cratered 79 percent; Williams Cos. fell almost 77 percent; Vitesse Semiconductor tumbled 72 percent; Nortel Networks plunged nearly 69 percent; and Lucent Technologies lost 68 percent.

The biggest gains were found among defense, consumer and homebuilding stocks: Big Lots rose over 38 percent; Aetna was up just over 26 percent, Lockheed Martin gained 24 percent; Pulte Homes, jumped almost 22 percent; and Coca-Cola Enterprises rallied around 20 percent.

Headache after headache for investors

There was no shortage of terrorism alerts, Middle East violence, profit warnings and accounting blowups throughout the second quarter.

Additionally, a sturdy economy -- the first-quarter's saving grace -- turned woozy in the April through June period as exhausted consumers paused.

Investors now fret that the U.S. consumer, the bedrock of the economy, will turn off the spending spigots at a time when business spending has not yet picked up. That would spell disaster for the economy, profit growth -- and the stock market.

But there are glimmers of hope: The Fed is expected to stay sidelined for some time; the economy, while softer compared with the previous quarter, remains on a recovery path; and negative pre-announcements from companies are running at a slower pace vs. previous quarters.

Additionally, the markets weathered this week's accounting storms with surprising resilience.

Xerox's news Friday was the latest in a string of bookkeeping scandals that have rocked the stock market in recent months.

The fraud discovered at WorldCom earlier this week sent shockwaves throughout the financial markets and took another stab at investor confidence -- already bruised and battered by the Enron debacle, the sliding dollar and worries about terrorism.

But the stock averages came back from crushing losses on Wednesday -- the trading day after the WorldCom news hit -- to end near the unchanged mark. And stocks were up for most of Friday's session as investors isolated the Xerox news, punishing only the company's shares.

Tom Stevens, chairman and president of Los Angeles Capital Management, said another potential bombshell for the market was averted. "We may be at a point where most of the bad news has already been digested."

The market, Stevens said, has been purged of the euphoria and outrageous valuations characteristic of the late 1990s.

"Now it's back to basics when figuring where to invest," Stevens said. He continues to favor value vs. growth and small-sized stocks vs. big-cap names.

Standard & Poor's Arbeter said stocks have not seen the kind of accumulation to suggest an intermediate-term advance is in the offing.

"[The accumulation] must occur over the next couple of weeks and [should] be on strong volume. New advances must show firm evidence that institutional distribution has been replaced by strong accumulation patterns. Until that happens, it's certainly not the time to jump back in with both feet," the analyst concluded.

Dollar is key

The dollar, which is knocking on the parity door against the euro, could be one of the keys in the second half. Its declines have raised red flags on Wall Street because of its implications for foreign investments in the U.S.

"Foreigners have been toasted by their M&A and equity purchases over the last several years. The mark-to-market losses for foreigners are monumental," said research and money management firm Bridgewater Associates.

Bridgewater believes foreigners will shy away from U.S. assets for a long time, as they are still "massively overweight" in U.S. securities.

In the meantime, the U.S. needs to finance a ballooning current account deficit.

"This very combustible mix will likely lead to a much more significant decline in the dollar than most have contemplated," Bridgewater said.

Earnings and data watch

Thomson Financial/First Call maintained in its weekly research note that the news still remains good for the second-quarter reporting season, which will begin in earnest in two weeks.

"Negative pre-announcements are still running much less than normal, the estimate revisions are still no more than normal trimming, and we would expect the reported earnings surprises to be at least as good as normal," First Call said.

But the pressing issue is what will happen in the second half of 2002.

The earnings compiler said an emerging problem for the second half, particularly apparent in the last two weeks, has been an acceleration in downward revisions to third-quarter estimates. The severe cuts in capital spending related sectors ahead of the third quarter are ominous, First Call warned.

In the meantime, only a handful of companies will report their results next week. Among them: Research in Motion, Interstate Bakeries and Supervalu.
Want to know more about the market? FREE membership at CBS MarketWatch includes advanced charting, portfolio tracking, email alerts and e-newsletters with expert tips and commentary.

http://biz.yahoo.com/cbsm-top/020701/375162d1961a96352aba9022aebc6175_1.html