September 2000, Part II
Brian Trumbore
President/Editor, StocksandNews.com

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.

---

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

BUYandHOLD does not offer or provide any investment advice or opinion regarding the nature, potential, value, suitability or profitability of any particular security, portfolio of securities, transaction or investment strategy. Any investment decisions you make will be based solely on your evaluation of your financial circumstances, investment objectives, risk tolerance, and liquidity needs. The securities mentioned above are being used for illustrative purposes only and should not be regarded as an offer to sell or as a solicitation of an offer to buy and past performance is no guarantee of future results. The opinions expressed above are not necessarily those of BUYandHOLD, its officers, directors or its affiliates.