"But I think we are going to have the sharpest recession we have had since World War II. "
On the Level: Wilson Weighs In
By Brett D. Fromson
Chief Markets Writer
3/7/01 5:47 PM ET
Robert Wilson was a better stock investor than you'll ever be.
Maybe Warren Buffett could claim to have outperformed Wilson, who retired in 1986, but you still might want to listen to what this near-billionaire has to say about stocks today. He's still smart. He's still contrary as hell. And, most important, he's a proven moneymaker who has survived and prospered through some of the worst bear markets in U.S. history. He was a growth-stock investor who also sold short so that he could get that much longer without blowing up during downturns.
Last April, we sat down with Wilson and talked about the stock market. Wilson was bearish and, in retrospect, right. We chatted again the other day.
What does he think about the market now? Let's just say that he wouldn't necessarily agree with today's bullish call from Goldman Sachs' Abby Joseph Cohen.
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Brett D. Fromson: Bob, what's your view on the market now? You were rightly bearish last year.
Robert Wilson: Whenever we have a period when things go extraordinarily well -- certainly this was the case with me in the stock market -- you begin to think you are God. And for a while, believe it or not, you are. That never lasts very long. Just the sheer hubris and overconfidence that makes you think that starts to make you sloppy. When that happened, I would get my comeuppance in the market. I think the same is true with the economy today -- it has been almost godlike for the past few years. In my view, because the economy has been unusually good, it stands a good chance to be unusually bad going forward. That's just life. Now that doesn't mean that it will be unhappy as long or as intensely as it has been happy. In the long run in America, the sellers have been wrong and the buyers have been right, and that will remain the case. But I think we are going to have the sharpest recession we have had since World War II.
Brett D. Fromson: Why?
Robert Wilson: There has been massive misallocation of capital. The money that has gone into the Internet and telecommunications areas, by which I mean a lot more than the dot-coms, has simply been excessive. As you know, there have been these very high P/E stocks. Excuse me, I didn't mean to say earnings. Let's just say there have been these very high price-to-whatever stocks. And then there have been the "value" stocks that have been dogging it at 10 times earnings or less.
If you are running a company whose stock is selling for 10 times and you have free cash flow, you will probably buy in stock. That makes sense because the market is saying, "We don't want you to expand." That is what the market has been telling the electric utilities and the oil companies, for example. In contrast, the market tells the very expensive companies with highly valued stock, "Keep on investing, and we will give you more money." This phenomenon has led to a massive misallocation of investment over the last five years.
Brett D. Fromson: Do you think recession is a close call?
Robert Wilson: It's always a close call because nobody ever really knows, do they? I'm not an economist. All I know is that consumers have been spending way beyond their means. The country has been living way beyond its means as measured by the huge balance-of-payments deficit we have. But except for the last six months, the economic surprises have been pleasant for about five years. The idea that we could have several years of unpleasant surprises most people find viscerally unimaginable.
Brett D. Fromson: So, how do you see this playing out in the stock market?
Robert Wilson: My understanding is that corporate return on capital and return on sales have been well above average historic rates lately. So, I would first ask what are the average long-term earnings of the S&P Industrials, and then I would assume that they go below that level in this recession. Then I would put the current P/E multiple on those depressed earnings because normally higher multiples are assigned to above-average earnings. What would a reasonable P/E ratio be for the S&P? I think it would be down more than 50% from the high for the tech companies in the S&P and less for the value stocks in the index. (The P/E on the S&P Industrials is down about a third from a year ago.)
Brett D. Fromson: Does this period of time remind you at all of the last great bear market for U.S. stocks in the early 1970s?
Robert Wilson: I see no similarity at all. In the early '70s all the economic problems were out in the open. They were in the newspaper. Everyone knew what was wrong. I think in this market we are at a stage where we don't fully know what is wrong yet. Things are going to come out as they always do, and there will be a lot more negative surprise than people yet expect.
Brett D. Fromson: Do you expect to see many hedge funds blow up before this is over?
Robert Wilson: I think the good hedge funds will survive, if only because they can short stocks. The mutual funds are another story. I think before this is over some mutual funds will just have to close their windows because of losses and redemptions.
Brett D. Fromson: Are you at all concerned about inflation?
Robert Wilson: Not really.
Brett D. Fromson: How would you position yourself if you were still investing in stocks?
Robert Wilson: I wouldn't be in the market. I would be in cash and bonds. The problem today is that even the bottom 20% of the stocks in the Dow or the S&P are not really cheap. They are simply cheap relative to everything else in the market but not cheap on a historical basis.
Brett D. Fromson: Do you expect to see a day before too long when cheap stocks get cheaper?
Robert Wilson: They always do in a downturn. Cheap stocks don't go down as much as the market, but they go down.
Brett D. Fromson: What is needed for tech stocks to come back?
Robert Wilson: Technology will be growing. But when will the stocks come back? It might be a while. The group isn't going to come back until stocks like priceline.com (PCLN:Nasdaq - news) are selling not at $2 a share but at 1/8. When the tech overvaluation is done, we will have undervaluation. Then there will be opportunity when people are picking up the pieces and figuring out what works.
Brett D. Fromson: Are we there yet?
Robert Wilson: There are still companies that lose money and will run out of cash that have market caps in the hundreds of millions and billions of dollars. They have to go away before a real rebound.
Brett D. Fromson: What is the key for the overall market?
Robert Wilson: How much will consumers retrench. The key is how much consumers are going to be thrown off balance by rapid declines in their net worth. Something like 65% of household assets are in stocks. I worry about the fact that most investors still don't believe that stocks are really headed down. In every market break since 1974, if you had gone in and bought, you would have been way ahead. This bull market has been going on since 1974. It's been going on for 26 years.
Brett D. Fromson: Do you expect some scary days before this is all over?
Robert Wilson: The scary days tend to occur at a bottom -- the so-called "selling climax." One of the few technical things I have always put a lot of faith in is the triangle formation -- ascendant and descendant triangles. Generally, when a stock fluctuates, the long move tends to be the well-considered move and also the long end of the triangle.
The theory is that if a stock is in a primary bear phase, its goes down gradually. That is a descendant triangle. I think we are probably in a descendant triangle now. The slow decline in stocks is the well-considered move. The sharp upward moves are the impulsive ones. So my guess is that if we are really in a bear market, stocks will continue to drift down. Keep in mind that except for the Nasdaq, we are not down that much. My guess is that the market will continue to erode and erode, and then all of a sudden people will say, "Gee whiz, I can't afford to send my kids to college. I can't afford this. I can't afford that." Then there will be blood in the streets. I think the market could be much lower. You read the papers. Very few people are talking about the most serious recession since the end of the war. The economists say there isn't going to be a recession.
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Read more of what Wilson has to say in Part 2. .
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Brett Fromson writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He invites you to send your feedback to bfromson@thestreet.com.
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