Wall Street History

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Wall Street History

09/02/2005

September 2000, Part II

Continuing with my look back at a key market anniversary, Sept.
1, 2000, the following, taken from my “Week in Review”
archives, helps capture the mood and debate in the financial
markets as stocks tried to recover from the bursting of the bubble
earlier in the year. Some of the things I was writing were bang
on, especially on the “valuation” front. On other points I was
wrong.

Everything is a quote from WIR, except where noted in [ ]s.

Reminder

All-time highs

Dow Jones 11722 [1/14/00]
S&P 500 .1527 [3/24/00]
Nasdaq 5048 [3/10/00]

September 1, 2000

Dow Jones .11238
S&P 500 ..1520
Nasdaq .4234

7/22/00

There was an interesting piece that crossed the Reuters wire last
weekend, an interview with Yale Professor Ray Fair. He
commented that the Federal Reserve is dealing with the most
delicate market scenario in history. The main premise being that
too much “wealth effect” has been baked into the market and that
if inflation really did pick up, the Fed would raise interest rates
substantially higher, even if it meant a market crash.

But fear not, Fed Chairman Alan Greenspan made his semi-
annual appearance before the Senate Banking Committee on
Thursday and he said what everyone wanted to hear. The
economy was slowing and there was a good chance we would
see a soft landing. Stocks and bonds took off on his testimony.
[Though they ended up finishing down on the week.]

In fact, the Fed’s projections for 2001 would be just perfect;
GDP of 3.25-3.75% with 2-2.5% inflation.

[For this week I was bullish on the economic outlook and
concerned about inflation.]

Aside from Greenspan’s remarks, the market was dominated by
news on the earnings front. Since way back, I have never
questioned the earnings outlook for the first half of 2000 and the
raw #s continue to be strong.

But while stocks like Sun Microsystems and IBM reported
figures that were well received, others like Lucent and Agilent
were pummeled. Which leads me to a topic I promised to
discuss at length

Valuation

My problem has never been with the market level of the Dow
Jones (or the valuation of much of the S&P 500). It’s the Nasdaq
that bugs me. But let me give you both sides of the valuation
argument.

Ed Kerschner, noted strategist at PaineWebber (and a man who
has called this bull market as well as anyone), wrote a
commentary this past May 30 wherein he said that “in the long
run, only two things determine stock prices: earnings and P/E
(with P/Es, in turn, a function of expected earnings growth). So
a very fast growth rate is worth a very high P/E multiple. In a
low inflation environment, the S&P 500, which has a 7% secular
earnings growth rate, is worth a 30X P/E (its current trailing 12
month multiple). A 15% growth stock is worth a 65X P/E. And
a 20% growth stock is worth a 106X P/E.”

Now the historical market multiple on the S&P 500 is about 14.
So you see his point that stocks growing faster than the market as
a whole deserve to be rewarded as such.

But the other side is represented in an article which will find its
way into every history book on the Great Nasdaq Bubble of
1999-2000, Jeremy Siegel’s piece in the March 14 edition of the
Wall Street Journal.

At the time, the Nasdaq was just beginning to crater from its all-
time peak of 5048. Siegel, one of the preeminent market
historians and author of “Stocks for the Long Run,” writes:

“History has shown that whenever companies, no matter how
great, get priced above 50 to 60 times earnings, buyer beware

“But many of today’s investors are unfazed by history – and by
the failure of any large-cap stock ever to justify, by its
subsequent record, a P/E ratio anywhere near 100.”

When Siegel wrote the piece, Cisco, Sun Micro and Oracle, for
example, were all at highs and had P/Es in excess of 100 (based
on trailing 12 months).

“Once a firm reaches big-cap status – ranked in the top 50 by
market value – its ability to generate long-term double-digit
earnings growth slows dramatically.”

So far, in the 4-plus months since the article, Siegel’s theory has
begun to take shape. But where are we today?

I’ve picked 6 leading, market bellwether, technology issues.
Next to each is the projected P/E based on 2001 earnings
estimates and Friday’s closing share price. If you’re in the camp
that says the economy will slow, in earnest, perhaps the earnings
estimates are too high.

Cisco – P/E 97
Oracle – 83
Sun Micro – 79

Again, this is for 2001, not 2000 earnings. And for Sun, I took a
revised earnings forecast issued this Friday of $1.32 (as
estimated by a leading analyst who, interestingly enough, also set
a $130 price target a 100 P/E).

And all three of these companies are projected to see earnings
per share growth of around 30% in 2001 and 25% or so in fiscal
2002 a gradual deceleration befitting their mammoth size.

In all three cases, I would submit the upside is limited.

Now the other three companies and their projected 2001 P/Es.

JDS Uniphase – exactly 200 $134, 2001 EPS est. of $0.67
Rambus – 225
Yahoo! – 238

All of these are leaders in their fields no one is questioning
that. But they are not only priced for perfection, they are priced
for nirvana!

These latter three are also no longer startups. I’m sure Professor
Siegel would agree with me that it’s hard to build a case of
investing in them. And if these stocks ever really disappoint, a la
Lucent, you are looking at a 40-50% hit in one day.

--Do you want a couple of examples of how bad things are in
dot-com land? CD Now, once trading at $35, received a takeover
offer from Bertelsmann for around $3. And DrKoop.com is
receiving some kind of offer as of Friday afternoon. The market
is telling you that if it’s real, the company may fetch about $2. It
once traded at $45.

7/29/00

Confused? I’m not surprised. The advice you get on Wall Street
is pretty lousy.

Any market strategist with half a brain knew that as the year
2000 progressed, the market was increasingly priced for
perfection. But many analysts just kept raising their targets,
either on the market averages or individual issues.

The spring debacle, particularly in the Nasdaq, showed investors
that valuation, and feasible business plans, did matter. I felt that
the pricking of the bubble would cause great pain. It did but
soon after the April 14 drubbing [when Nasdaq plunged 25% on
the week], many had you believe that it was off to the races
again.

And like punch-drunk boxers, investors took this advice, raised
their heads and bought some shares in the very same issues that
caused pain before, only to get smashed right in the face once
more.

But will those who believe valuation doesn’t matter keep getting
back up? Or will the referee hover over their bodies, urging
them to quit?

Yesterday, the GDP for the 2nd quarter was released and the raw
number, up 5.2%, was greater-than-expected. But the pace of
consumer spending in the 2nd quarter slowed considerably, up
only 3% vs. 7.6% in the first quarter.

Oh, you mean consumers may have actually felt the pain a bit
from the slide in the Nasdaq?...But we do want the economy to
slow, right? So why did the Nasdaq slide over 4% on Friday, on
its way to its 3rd worst week ever, down 10.5%?

Earnings? Warnings on future earnings? But I was told by the
experts two weeks ago that earnings warning season was over
and the only thing we had to fear .was fear itself!

Well folks, if you doubted that we need a missile defense before,
think again, because the bombs were flying on Wall Street.

Bamm! Amazon.bomb, now down to $30 and just two weeks
after I mentioned in this space that an analyst had raised his
target to $130. It seems that Amazon’s growth rate for its core
businesses is downright abysmal.

Bamm! Nokia and WorldCom warned that the second half may
not be as rosy as originally thought. Nokia lost 25% of its value
on Thursday alone.

Bamm! Priceline.com issued what it thought was a respectable
report. It’s now at $25 anyway. Not too long ago an analyst set
a target of $190. [Apologies to Emeril.]

Oh, there were countless other horror stories. Suddenly you look
up and the Nasdaq, at 3663, is now back to 27% below its all-
time high. And while the Dow Jones, as I expected, has fared
much better, it is once again 10% from its record level at 10511.

So what’s it going to be from here? Well, ironically, most
traders felt that expectations for earnings had changed going
forward as the slowdown works its way through the balance of
the year. True, earnings will grow at about a 20% clip when all
is said and done for the 2nd quarter, but the early estimate is for
18% growth in the 3rd and 16% in the 4th. You get the picture.
There’s a trend.

But as I’ve written the past few weeks, I’m not so sure this
slowdown will last and I saw plenty of evidence to back that up
in strong home sales, huge orders for durable goods and upticks
in consumer confidence. Yes, I think the Federal Reserve is
going to have to raise rates again but probably not in August
because the recent inflation numbers have been exceedingly
tame. I’m just increasingly convinced that we could be in for a
big shock after the election, which the markets will begin to
anticipate well in advance.

And I have to add a personal anecdote here. I made my 5th
purchase of a computer in the last 3 years this week and the price
was above PC #4 (comparable machines). I saw a gentleman I
respect tremendously say on “Wall Street Week” that PC prices
were continuing to fall. I don’t see it.

In this same vein, it was announced this week that U.S. PC sales
slowed considerably in the second quarter. I think two things are
at work here.

I mentioned way back that there would come a point in time
when corporations wouldn’t automatically upgrade their
employees’ machines with every new Windows update, and
maybe we are beginning to see that. But on the personal PC
front, you can’t convince me that it isn’t still the best delivery
system for today’s technology. As the telecom industry is
learning, we are nowhere near a world where everyone strains
their eyes to click through the Web on a little hand-held device,
let alone at the outrageous prices you have to pay today for an
inferior product and service.

[Reminder .I was referring to Web access, not e-mail devices
such as the Blackberry.]

And lastly, back to analysts. Their day is largely over. Probably
the biggest change we’ve seen in the past month or so is that
when an influential one issues a bullish statement, investors are
increasingly sneering, “Yeah, heard that before.”

--Michael Lewis wrote the following comment on Deutsche
Telekom’s acquisition of VoiceStream Wireless:

“Was I the only person in the world who had never heard of
VoiceStream? This little pissant cell phone company –
apparently the eighth-largest in the U.S. – has a mere 2.3 million
customers. Attempting to explain himself, Ron Sommer, the
CEO of Deutsche Telekom, sounded very nearly like a man who
knew that he had just made a truly grotesque miscalculation.
Yes, he said, he was paying many multiples of what any cell
phone company has ever paid for 2 million customers

“ Never mind that with $53 billion (it’s actually a little lower),
Deutsche could have bought a toehold in the U.S. far more
secure than VoiceStream Wireless. Say, for example, the state of
Rhode Island.” [Source: Bloomberg News]

--Tokyo’s Nikkei Index fell back below 16000 to close the week
at 15838, its lowest level in 2 months. That makes it about 15
times in the past year that another strategist has to eat his words.
“Japan is the next great opportunity ”

--Energy: Crude oil has been tumbling, to the extent where a
basket of various grades is now trading around $25.25. This is
important because that is smack dab in the middle of OPEC’s
$22-$28 preferred band .

But the cost of gasoline is now a political issue, even though the
price is coming down. Know the following. Domestic oil
production in this country has fallen from 7.2 million barrels per
day in 1992 to 5.8 million in the first half of this year. Of course
at the same time we are consuming more. The Clinton
administration has put up all manner of roadblocks to prevent
Big Oil from accessing federal lands.

--Since I mentioned him last week, PaineWebber’s Ed Kerschner
issued a new forecast on Monday, calling for 12-15% gains in
the market averages by 12/31/01. This was before this week’s
slide. Regardless, not a spectacular forecast and, as he aptly put
it, any gains will come in just a few individual sessions, meaning
that “the rest of the time you’ll feel stupid.” And yes, among
Kerschner’s stock selections were Cisco, JDS Uniphase, and
Oracle issues I highlighted last week as well.

[Note: I also wrote the following this particular week, regarding
the August 1998 bombing of a pharmaceutical plant in Sudan.]

“The owner of (El Shifa) has sued the U.S. for $50 million as a
result of the bombing of his factory..., when the U.S. claimed the
plant was manufacturing chemical weapons. Government
sources now admit we were in error .

“From time to time I think back to the end of the Gulf War when
we had a real opportunity to make progress with some of the
Muslim nations and their fringe elements. Our prestige in the
Muslim world was at an all-time high. And, of course, we blew
it. A troubleshooter like Henry Kissinger should have been
unleashed in the area. But nooo we stupidly bomb a plant in a
nation that is already a hotbed for terrorism and then we wonder
why we are a target. And it’s also why every time I pass through
the World Trade Center I’m looking for briefcases propped up
against the wall.”

[The Concorde crashed this week and the Napster debate over
downloading was heating up.]

--A Business Week / Harris survey found that 76% had no clue
who GE’s Jack Welch was. 99% knew Bill Gates.

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I thought I was going to wrap up this review of the times this
week, but I forgot how important the themes were the weeks of
7/22/00 and 7/29/00. As for stocks, after Nasdaq’s 10.5%
drubbing, the major averages were to embark on a five-week
winning streak that would carry them to the highs of 9/1/00.
We’ll plow through it all next time and then get to Bre-X after
that.

Brian Trumbore

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