BARRON'S Oct 4, 1999 : Half-Full, Half-Empty ?
Half-Full, Half-Empty
What's ahead now that the market has seen a 10% drop from
the high?
By Jonathan R. Laing
It's official. The stock market has now reached "correction" levels with both
the Dow Jones 30 Industrials and the Standard & Poor's 500 Index trading
last week more than 10% below their respective highs of 11,326 on August
25 and 1418.78 on July 16. This at the very beginning of the historically weak
market month of October. And adding to the gloom has been the even
weaker performance of the average listed and unlisted stock, compared to the
large-cap stock-dominated indexes. Indeed,something of a stealth bear
market has been under way for some months.
According to a recent report by Donaldson Lufkin & Jenrette, the individual
500 stocks of the S&P have fallen an average of 23.5% from their respective
52-week highs, while the top 100 S&P stocks by market weight are now
down some 20%. Increase that universe to all Big Board and Nasdaq issues
with market capitalizations of more than $150 million and the story is even
worse. They've dipped an average of 27% below their 52-week highs.
Moreover, more than 60% of all Big Board stocks are down, year-to-date,
as are six out of the 11 S&P groups. industry
But of course, we're not telling investors anything they don't
know if, perchance, they have been fortunate enough to
own a portfolio dominated by such large-cap vestal virgins as Microsoft, Intel,
Cisco, General Electric and IBM.
Yet the big question remains: Has the
stock-market correction run its course or is the recent carnage a mere prelude
to something far more ugly?
No one can be sure, certainly. But to help guide our gentle readers, we've
queried some of the sharpest stock-market observers we could round up. As
expected, sharp fundamental differences exist in their market views. However,
all have provocative insights that should be of some value to any student of the
market.
One of our longtime favorites is Deutsche Bank Securities' chief economist
and global market investment strategist,
Edward Yardeni. As the godfather of
the economic New Paradigm School, he presciently predicted much of the
bull market of the 'Nineties.
Yet his concerns over things like Y2K computer
disruptions and market overvaluation have left him decidedly bearish on the
stock market and the global economy's prospects in late 1999 and the first
half of 2000. Nothing he's currently seeing has disabused him of that notion.
Unmistakable signs of unsustainable mania abound, according to Yardeni.
Last month saw cover stories in both
Time magazine ("GetRich.com.") and
the Atlantic Monthly ("Dow 36,000") that are symptomatic of grandiosity and
magical thinking.
The dot-com IPO boom is yet another aspect of today's speculative bubble,
according to Yardeni. Though few of these companies will ever
earn a dime or even survive, they've produced
billions of dollars in IPO proceeds. And these, in turn, give company
executives and venture capitalists the wherewithal to indulge their wildest
fancies. The IPO money, of course, soon recycles into the real economy as
enriched company operatives tear down and then build fancy homes along the
Pacific and buy all manner of servers, routers and PCs for their fledgling
concerns.
But according to Yardeni, this gross misallocation of capital can't persist
forever. And when this bubble bursts, the impact will radiate throughout the
economy, hurting providers of tech equipment and high-ticket consumer
products alike.
At the same time, Yardeni worries that Y2K concerns may cause some
institutional investors to stop trading in December because of fear of
settlement problems.
This may, in turn, exacerbate the ebbing in the flow
of money into U.S. stocks that has been evident over the past year. In the
second quarter of 1998, money was pouring into the market at an
annualized rate of $385 billion; the latest available data show that the rate
has slid to just $191 billion. Foreign investors also have cooled to U.S.
stocks in recent quarters.
Finally, the economist sees a passel of other factors likely to chill stock prices
over the coming months.
Y2K-inspired inventory hoarding by American
companies may lead to further negative surprises on the U.S. trade deficit
front after the huge deficit numbers recently reported for June and July.
Yardeni adds that the supply chain problems in the high-tech industry caused
by the Taiwan earthquake only point up the potential global disruptions that
Y2K computer problems may cause.
In addition, he claims that recent rich
wage settlements such as those in the auto industry could materially squeeze
corporate earnings growth next year and beyond.
As a result, he sees a sell-off coming, which will take the Dow down to
around 8000 by early spring of next year and a bear market that persists until
at least the late summer or the fall of 2000. And then it will be onward and
upward to his longtime Dow target of 15,000 by 2005.
Yardeni isn't the only one worried about the inevitable collapse of the Internet
IPO bubble.
Chicago billionaire investor Sam Zell, celebrated among other
things for his astute timing of real-estate cycles, is talking about little else these
days. According to Zell, 'Net-related advertising on a chain of radio stations
he controls-Jacor Communications-has risen from 0.25% of volume in 1998
to over 8% now. He suspects the same is true for a lot of other media
companies. And what of all the online outfits renting fancy space in
commercial office buildings?
"The point is that the money which is being used to buy ads and fill up
suburban glass towers is coming from recycled IPO proceeds and not
corporate earnings, since most 'Net companies have never and will never
make any money, " he observes.
"This phenomenon is totally artificial and
unsustainable. And when the IPO window finally slams shut, and it will soon, I
expect it to trigger a nasty correction in the U.S. economy."
The U.S. consumer, of course, has been a stalwart in helping to fuel the
'Nineties boom.
Yet Ken Safian of Safian Investment Research in White
Plains, New York, claims
to see signs that the increasingly leveraged
consumer finally may be running out of the financial firepower to sustain good
times, even with continued strong growth in personal income and wealth from
appreciation in stock portfolios and housing.
The consumer's plight shows up in a ratio that Safian closely tracks of
household money flows into bank accounts, money-market funds, mutual
funds, insurance products and the like to changes in household debt.
The ratio
has been in free fall since the beginning of 1998, indicating that liquid assets
generated from personal savings, home-equity loans, stock sales and other
household capital-raising measures have been growing materially slower than
household debt.
The ratio now stands at a level that typically signals a secular
peak in consumer spending and often precedes a recession and tough times
for stocks.
Such dark thoughts are but music to the ears of DLJ market strategist Thomas
Galvin, who earned his bullish chevrons by hanging tough on the long side of
the market even during scary smash-ups in the fall of 1997 and 1998. He
senses yet another bear-market head-fake this time around. In fact, he's
predicting a "Millennium Melt-Up" kicking off this January that will boost the
S&P to his target of 1680 and the Dow to 13,000 by year end 2000.
To Galvin, no bear market now impends because one already has hit the
many stocks now more than 20% below their highs. In fact, only about 20%
of all Big Board issues are above their 10-week moving average-an
extraordinarily weak reading and one that has heralded a number of
spectacular buying opportunities since the 'Eighties.
Meanwhile, obdurate pessimism reigns, such as is rarely seen at the onset of a
secular bear market. All year, the number of dollars flowing into money funds
has been nearly twice the total going into equity funds. Fears abound of a
further Fed interest-rate hike this week or later in the year, a rising trade
deficit, the dollar's weakness versus the yen, Y2K, rising energy prices and
corporate earnings disappointments in the third quarter and beyond.
Galvin finds these concerns vastly exaggerated. For example, the borrowing
costs for both consumers and corporations already have risen more than
twice the 50 basis points that the Fed already has hiked rates, so there's little
to fear from another tightening. The looming $300 billion annual trade deficit is
hardly onerous to an economy of the vigor and size of America's, especially
taking into account the U.S.' reduced borrowing needs resulting from its
projected $120 billion fiscal 1999 budget surplus. The trade deficit will drop
anyway in the months ahead as a result of a weaker dollar, slowing U.S.
consumer spending and global recovery.
Corporate profits? No problem, says Galvin. Many of the pre-announced
earnings disappointments have come from "habitual offenders" like
Coca-Cola, Gillette, Sears Roebuck and Advanced Micro Devices, which
have been taken to the woodshed in prior quarters. In fact, he foresees 20%
or more growth in earnings per share for the S&P in the third quarter, spurred
by technology and financial companies and energy and basic-industry firms.
And he sees no reason to change his 12% earnings growth projections for
both 1999 and 2000. "Just as financial engineering drove profits for the past
three years, stronger global growth and a weaker dollar will likely power
profits for the next three years," he asserts.
Goldman Sachs' Abby Joseph Cohen, who has achieved near iconic stature
among investors for her sang froid during the twists and turns of the 'Nineties
bull market, remains serenely bullish. She recently raised her yearend price
targets for the Dow to 11,500 and the S&P to 1385, based on upwardly
revised profit expectations for 1999 and 2000.
Inflation remains quiescent, and she thinks the bond market's pyrotechnics are
mostly over. In her opinion, the bears aren't giving sufficient credence to the
durability of the latest profit cycle. And perhaps most important, skeptics are
ignoring the ongoing management revolution in U.S. corporations that has led
to record profit margins, productivity-boosting capital investment and surging
returns on investment. She noted in a recent speech in Washington that this is
a secular rather than a cyclical phenomenon. Finally, the stock market is
currently some 5%-10% undervalued, according to her models.
Laszlo Birinyi of Birinyi Associates in Connecticut, likewise dismisses many of
the bears' concerns. As a mechanism that looks into the future, the stock
market has long since discounted all the worries, such as rising commodity
prices, the dollar's weakness and rising interest rates, he insists. "Real bear
markets come when nothing seems to be going wrong," he avers.
Birinyi insists that the bull market is still intact, and he's maintaining his yearend
target for the Dow of 12,000. He further notes that the greatest stock
accumulation measured by his firm remains in technology, financials, energy
and selected cyclicals. Nor does shrinking market breadth, with fewer stocks
participating on the upside, particularly bother him.
"The stock market is a meritocracy, not a democracy, so if just 50 stocks are
performing well, then buy them," he advises with a hint of sarcasm. "What the
bears don't realize is that the glass is still half full, not half empty," Birinyi
declares.
Most investors would surely drink to that
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