To:Tom Toxby who wrote (23394)
From: Zakrosian
Wednesday, Aug 8, 2001 4:12 PM
Respond to of 23414
Here's another view of the market:
Seeing Bubble
By Robert J. Samuelson
Wednesday, August 8, 2001; Page A19
It may be that the U.S. stock market is still overvalued, even after a year of losses that have left all the major indexes trading well below
their historical highs of early 2000 (11,723 for the Dow, 1527 for the Standard & Poor's 500 and 5049 for the Nasdaq). The Nasdaq
has been virtually annihilated and is trading at roughly 40 percent of its peak. Among technology companies -- even those with profits --
the slaughter has been almost universal. Microsoft is down 44 percent from its high, Intel 58 percent and Cisco 75 percent. The bubble
has burst. Game over.
Well, maybe -- and maybe not.
Consider the market's price-earnings (PE) ratio. The PE compares a stock's price with the company's earnings (profits) and is a basic
tool of financial analysis. At the end of July, the PE for the entire S&P 500 group of stocks stood at almost 27: stocks were priced at 27
times their companies' recent earnings. That's nearly twice the historical average of 14.5 going back to 1870, according to finance
professor Jeremy Siegel, author of "Stocks for the Long Run." Stocks supposedly represent the present value of all future profits, so
today's astronomical PE must mean that either (a) despite the economic slowdown, the long-term outlook for profits remains strong, or
(b) investors are collectively crazy -- the market will drop or stagnate for years because stock prices have gotten way ahead of profits.
Of course, most investors hold firmly to (a). If they didn't, the market would be lower. Inflows to stock mutual funds, though down from
last year, remain healthy: $47.5 billion for the first half of 2001. Many investment professionals feel similarly. One survey of investment
newsletters classifies 46 percent as "bulls" and only 28 percent as "bears." Just last week, respected stock strategist Abby Joseph Cohen
of Goldman Sachs told CNBC that the worst is over for the economy and the market. But this reassuring consensus has some notable
dissenters.
"I am still skeptical that an economic recovery is just around the corner and that The Bottom [of the market] has been made," writes
Barton Biggs, a senior investment strategist for Morgan Stanley. "It strains credulity that so gigantic a speculative boom dissolves into
so mild a bust that almost everybody goes happily on their merry way again."
If Biggs is right, the economy could lose one of its last shields against recession -- consumer buying. Though increasing less than in
2000, it has cushioned the fall in business investment spending. Consumer spending has in turn been buoyed by huge realized capital
gains, after-tax profits on stocks actually sold. In 1995 they totaled $140 billion, equal to 2.6 percent of disposable personal income, say
economists at Goldman Sachs. By 2000 they'd exploded to $534 billion, equal to 7.6 percent of disposable income. A lower stock market
would ultimately squeeze this source of cash and, almost certainly, weaken spending.
So who's right about the PE?
What's incontestable is that the PE has broken out of its historical range. "Until five or six years ago, anything above 24 or 25 was
considered absolutely shocking," says David Blitzer, chief investment strategist for Standard & Poor's. But in the late 1990s the PE for
the S&P 500 regularly reached the high 20s or low 30s. By Siegel's figures, it hit a record 34 in early 2000. Some of the rise represented
speculation. Stock prices were bid up to phenomenal levels even when companies had puny (or no) profits.
The simplest theory for today's high PE is that the speculative spirit survives. People continue to believe -- setbacks are temporary; the
New Economy promises a gold mine. Microsoft's present PE is a lofty 48, Intel's 41. Who knows what's right? It's impossible to say
what the market PE "should" be, because that would require knowing future profits, inflation and interest rates (bonds and bank
certificates are rival investments). No one knows any of these things.
Siegel attributes the market's high PE to a series of changes that, he argues, have made stocks less risky to hold: (a) Recessions have
become less frequent and milder, meaning less disruption of profits; (b) capital-gains taxes -- now generally 20 percent -- are the lowest
since 1941; (c) the costs of buying and selling stocks have dropped; and (d) low inflation may make stocks more valuable because
inflation-induced price increases aren't taxed as capital gains. "When you add all these up, I think a PE in the low or mid-20s is
justified," says Siegel. "But that doesn't mean it couldn't go back to 15."
Still, a high PE ultimately requires strong profits -- and this implies a speedy economic recovery. Stock PEs often rise in an economic
slump, because investors assume that profit declines will quickly be reversed. Well, there's plenty to reverse. Profits are dismal. The
official figures come from two sources: the U.S. Commerce Department and company reports. By the Commerce numbers, profits have
dropped 11.8 percent since peaking in the third quarter of 2000. But these figures don't include one-time write-offs and cover only the
first quarter of 2001. A Wall Street Journal survey last week of 1,138 company reports for the second quarter found that profits --
including write-offs -- were 67 percent below those of a year earlier.
"Businesses won't stop cutting jobs and capital spending until profits stop falling," says Mark Zandi of Economy.com. Like most
forecasters, he expects a revival by year-end. Lower interest rates, lower energy prices and the tax cut should restore confidence and
spending. Should this fail to occur, present market values will almost certainly qualify as another "bubble." It's also possible that the
drip, drip, drip of bad corporate-earnings reports will slowly drain investors' confidence and spontaneously depress the market -- and
the economy. Alan Greenspan likes to say that a bubble becomes obvious only with hindsight. But even now the market is providing an
impressive imitation.
© 2001 The Washington Post Company |
