THE SKEPTIC: Rosy Glint Is False Dawn; Beware The Bear
By Alen Mattich
A DOW JONES NEWSWIRES COLUMN
LONDON (Dow Jones)--The Dow has rallied back above 10000, a stranded Nasdaq
is beginning to show signs of life as it bobs back towards 2000 and the FTSE
100 has made a dash to within a loud shout of 6000.
But this glimmer of light is a false dawn. Perhaps it's even the burst of a
nuclear flash that precedes the meltdown.
Fundamentals say equity prices still have a long way to drop - by as much as
half for major equities indexes on either side of the Atlantic, and a lot
more for the tech markets.
Even after the punishing, year-long shakeout, considerable, and unrealistic,
earnings growth is still priced into stocks - unrealistic because these
expectations ignore both the current slowdown faced by western economies and
their long term potential.
Markets continue to say the part of the economic pie represented by the
corporate sector is growing faster than the pie as a whole. Indeed, growth
is so fast that before long the corporate segment will be bigger than the
pie itself.
That's absurd, of course, and it means prices are built on a platform of
impossible conjecture - a pie in the sky.
As ever, what happens in the U.S. is key to how and when Europe's shares
drift - or plunge - back towards reality.
And U.S. share valuations are still extraordinarily rich: the forward
price-to-earnings ratio for S&P 500 stocks is 22.4X, with projected annual
earnings growth of 16.1% over the next five years, according to Merrill
Lynch. The P/E on Nasdaq stocks is around 75X, with expected earnings growth
commensurately higher.
It doesn't take vast insight to reckon there's a serious gap between
earnings galloping at 16% annually and an economy plodding along at 0.7%
with inflation of around 3%. Even long-term sustainable numbers - the
economy growing at 3.5%, inflation at 2.5% and capital returns around 2% -
would still only result in about half the rate of earnings growth that the
market's plugged in.
Sustainable rates of economic growth imply P/Es a lot closer to the historic
norm of between 12X and 15X. That suggests that the S&P 500 still has a
walloping 40% to fall and the Nasdaq, already down 60% from its highs, by
another 60% or more.
And even though at first blush European markets seem to rest on healthier
fundamentals, they're just as vulnerable.
Euroland should grow around 2% this year. Except for high-tech disaster
areas like the Neuer Markt, European shares never quite achieved the
stratospheric valuations of their peers across the pond. And the weight of
the accident prone high-tech sector is smaller.
But that's only half the picture. A massive buying spree of U.S. assets
during the past few years and booming demand from U.S. consumers has left
European companies more heavily exposed to winds from across the Atlantic
than ever before.
More damaging still is the fact that big U.S. reversals have historically
been accompanied by even sharper falls among Europe's markets. Which means
another 40% or so off the FTSE 100, the Xetra Dax and the CAC-40. At least.
So why the recent revival? A glance at the chart of any bear market shows
any number of rallies, some lasting for months, littering the down trend.
Things are no different this time around.
-By Alen Mattich, Dow Jones Newswires; 44-20-7842-9286;
alen.mattich@dowjones.com
(END) DOW JONES NEWS 04-18-01
07:18 AM
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