CHARLAYNE HUNTER-GAULT: The stock market has been on a sustained high for a long time now until yesterday. That's when it started to drop, 68 points yesterday, 97 today. To help us analyze what's now moving the market, we're joined by Mary Farrell, investment strategist with Paine Webber. Mary Farrell, thank you for joining us. We've heard that this move downward has been blamed on the stalled budget negotiations. Is that right?
MARY FARRELL: (New York) That's part of it. And that's certainly the most visible in the catalysts today. But it's also the fact that earnings are coming in very disappointing for the fourth quarter.
CHARLAYNE HUNTER-GAULT: All right. Let's start with the stalled budget talks. Take us through that. I mean, Speaker Gingrich says that we're not going to have a deal possibly till November, and the stock market starts to drop. How exactly does that happen? Are people sitting on the edge waiting, and what happens?
MARY FARRELL: Well, I think a good portion of the stock market's gain last year was based on the premise that we would have a creditable budget deficit reduction package, that that in turn would take some pressure off interest rates, would resolve the inflation issue, i.e., keep inflation low, and that did push stock prices higher.
CHARLAYNE HUNTER-GAULT: And the connection with interest rates is what?
MARY FARRELL: Basically, the lower interest rates go, the more highly stocks are valued. If you can get a high return in interest rates buying bond with a high interest rate, stocks are relatively less attractive.
CHARLAYNE HUNTER-GAULT: Okay. Go ahead. I interrupted you. Sorry.
MARY FARRELL: So basically, now that it appears that we are not going to necessarily get one, and I think when we say a budget deficit package, that certainly means not the smoke and mirrors that we've often seen from Washington. The market is reacting very negatively.
CHARLAYNE HUNTER-GAULT: And when you say the market, I mean, who is it that goes and suddenly starts making it move?
MARY FARRELL: Interestingly, Charlayne, it's primarily institutional investors who tend to do the large volume trading on days like this. One lesson that has been learned by the individual investors in the post stock market crash of '87 environment is it really doesn't pay to trade these short-term moves; as long as the outlook long term is good, it's better to hold.
CHARLAYNE HUNTER-GAULT: Now, you say there were other, other factors as well, not just Gingrich's remarks.
MARY FARRELL: Yes. A very important factor which the market is going to have to face is that earnings growth is slowing. Last year was a very strong earnings year for the market. Corporate earnings were up on an operating basis about 19 percent, but as the economy slows, so do those earnings.
CHARLAYNE HUNTER-GAULT: And, I mean, are those the two main factors, or are there other things as well, because I was reading that there were other factors that in the last week or so in particular, that started to contribute to this.
MARY FARRELL: There are some other factors, and, for example, retail sales were very weak over Christmas. Automotive sales have been weak, and we are starting to see that, you know, kind of broadening in the economy. There's one little fact that's kind of interesting. Usually you get tax loss selling in the month of December before year-end. There's some belief we're seeing a lot of tax loss selling now, or actually tax planning taking gains, because of the possibility or probability we'd see some capital gains reduction.
CHARLAYNE HUNTER-GAULT: But also last month, I mean, the market- didn't the market drop 101 points in December?
MARY FARRELL: One ironic thing about this market is that it went up so strongly, over 34 percent last year, with very few corrections. We did have a few of those backtracking periods, but really not very much. Most bull markets get several 5 to 10 percent corrections. This one, remarkably, did not.
CHARLAYNE HUNTER-GAULT: So how seriously should we take this drop yesterday and today? I mean, is this a really big deal and something to really be worried about?
MARY FARRELL: If I were those congress persons and our President in Washington, I would take very close note here because I think the market really does reflect a lessening of confidence in what's going on in Washington, and I think they should respond to that. I think if you look ahead, you know, this period of slower growth, slower earnings is going to take its toll, but basically the outlook for the market is pretty good. This is a soft landing. You know, I think the Federal Reserve did a good job maneuvering us into a soft landing and relatively we're pretty healthy.
CHARLAYNE HUNTER-GAULT: But, you know, today after Speaker Gingrich said what he said about the budget deal, Sen. Dole said that he was very optimistic about a budget deal. How is- is that going to also factor into this equation and cause somemovement in the market, I mean, is it steadily going down now, or will it change, depending on things like that?
MARY FARRELL: Yes. I think two things. I think there will be very close watching on what goes on in Washington, and themarket will respond. This could turn on a dime if we came back with a creditable agreement in Washington. And the other thing is I think the market is going to focus very closely on earnings. They haven't had to worry about the practicalities. Last year, earnings were strong. The economy was moving. Unemployment was high. Interest rates were declining. This year not only do we not have the budget package, but we also have interest rates more stabilizing and earnings slowing. So it's not quite as easy out there.
CHARLAYNE HUNTER-GAULT: So is it possible to predict with any certainty in this very volatile environment what we might see tomorrow or the next day?
MARY FARRELL: I would hesitate to say with certainty. I'd feel probably most comfortable saying not that we'd see more of the same. I don't necessarily think we're going to see, you know, a 100-point decline sequentially here, but I think it is a nervous market which will wait for a sign that we do have progress in Washington, or else, it's going to have to come to grips with these lower earnings. So I think it's going to be very tough and go and expect more volatility.
CHARLAYNE HUNTER-GAULT: All right. Well, Mary Farrell, thank you for joining us.
MARY FARRELL: Thank you very much.