High PE Ratios Worry Value-Minded Analysts
By MATTHEW LUBANKO /The Hartford Courant
August 11, 2001
The Standard & Poor's 500 index today trades at 32 times earnings - and that has some analysts and money managers worried.
Though roughly three points below an all-time high, today's lofty price-to-earnings ratio in the S&P 500 is still more than twice its historical average of 14.5. A PE ratio is a measure of investor confidence, a quantifiable sign of what people are willing to pay for present and future profits.
In the late 1990s, cocksure investors often paid a high premium for corporate profits; some even paid a premium for companies showing no profits at all. But in the months to come, some fear, investors might grow a little impatient - and bail out of stocks.
Second-quarter corporate profits have posted a 12 percent year-to-year decline. The weary U.S. economy shows few signs of springing to life. And, perhaps most worrisome of all, investors' propensity to "buy on the dips" seems as bygone as Pet Rocks and fondue parties.
Both the Nasdaq composite and S&P 500 are on pace to post a decline for the year; if they remain underwater, this will mark the first time both indexes have declined for two consecutive years since 1973-74.
Yet not all signs point to dreariness and despair. The Fed has cut interest rates six times since January. Inflation remains low; inflation and high interest rates have been the twin bogeymen of bear markets past.
Federal income taxes will also decline for many U.S. workers - and this could give the economy a boost by stimulating consumer spending, some analysts said.
But the markets may have reached a point at which all this good news is not good enough, said Bill Meehan, chief investment strategist at Cantor Fitzgerald in Darien. And if that time has arrived, a market decline could ensue.
Forward-looking investors might, therefore, have to reconsider how they invest - and what returns they consider "acceptable" in the years to come.
"We could be in for regression to the mean,'' Meehan said. In such a regressive environment, investment returns might be on the order of 5 to 8 percent a year.
These returns would fall below the annual market average return of 11 percent, Meehan said, and would statistically counterbalance the 20-percent-plus returns enjoyed in the late 1990s.
"Nobody knows if we're in for a period of diminished expectations," but it's wise to remember that the markets have been through such periods before, Meehan said.
Some investors may recall brief periods in the 1990s and late 1980s when the markets treaded water - before running to new highs.
But the last sustained period for sideways motion occurred from August 1966 through August 1982. The Dow Jones industrial average, during this 16-year stretch, started at and returned to the low 800s; only dividends - and a few well-timed forays into oil and small-company stocks - enabled investors to show positive returns, market historians have written.
This year, the days of the dividend might have returned, said John LaForge, co-manager of the Phoenix Hollister Small Cap Value fund. Phoenix Hollister is a division of Phoenix Investment Partners in Hartford.
"Dividends are going to mean a lot more now. Companies that pay dividends tend to have strong balance sheets and predictable earnings,'' LaForge said.
With many of yesterday's high-tech stars offering scant hope for an earnings recovery, companies that can show even modest earnings growth could attract investor interest, LaForge said.
High-yielding stocks, LaForge added, provide some current income to offset losses suffered from declining stock prices.
Those waiting for a high-tech rebound, LaForge said, might be in for a disappointment.
"There are very few points [in history] where the market leaders of yesterday have been the leaders of tomorrow,'' LaForge said.
Oil stocks, for example, carried the 1970s, but lagged the markets in the 1980s. Pollution control and waste collection companies were the stars of the 1980s, but were the dogs of the 1990s.
Tech stocks dominated the 1990s, but have become the laughingstocks of 2000 and 2001.
But before giving up on a market rebound tomorrow, investors should remember that 2001 is not 1966 - or even 1976, said James Griffin, a consultant for Aeltus Investment Management Inc. in Hartford.
Gasoline prices, after rising briskly from March 1999 through this June, posted a 17.7 percent decline in July. Foreign money continues to pour into U.S. securities markets. U.S. workers continue to pump retirement-plan money into the stock and bond markets. And inflation and interest rates - the bane of all bull markets past - remain well below their recent historical averages, Griffin said.
"Nothing can destroy the value of a financial asset like inflation,'' Griffin said. Yet inflation today is hardly a worry.
(and if you think energy prices are going to stay low, guess again. PQ)
'We're on a treadmill' August 10, 2001
BY BRAD FOSS / Chicago Sun Times
DEW, Texas--In the dusty prairie midway between Dallas and Houston, roughnecks hired by Anadarko Petroleum Corp. work day and night to drill 12,000-foot-deep holes no wider than a saucer.
They pursue natural gas relentlessly, and they're not alone--nationally, 50 percent more gas wells are expected to be drilled this year compared to last.
But the new wells don't foreshadow a similar increase in natural-gas production. That means the gas shortages that drove up prices in the Chicago area during last year's heating season could be a permanent part of the U.S. energy picture.
Strong prices and stronger demand underpin much of the hectic drilling activity in Texas, but there is another reason for the 24/7 activity: Gas wells are being depleted ever faster, pitting industry against nature in a Sisyphean struggle to maintain a steady flow.
''We'll need tons and tons of these to help dig our country out of the mess we're in,'' Anadarko Chief Executive Bob Allison said of the region in East Texas where his company is sinking about 100 wells a year.
The ''mess'' refers to the 23 percent annual decline in U.S. base production, up significantly from 1990, when the output from existing wells shrank only 16 percent a year.
''We're on a treadmill that's making us go faster and faster just to stay even,'' said Skip Horvath, president of the Natural Gas Supply Association.
Last year 16,000 new gas wells were drilled, up nearly 60 percent from 10,400 drilled in 1999. But output rose only 2 percent over the same period, according to estimates from the Energy Department.
The industry is on pace to add 24,000 wells by the end of the year, with only a marginal uptick in production expected.
New drilling technologies allow the industry to tap gas reserves at greater depths and from a variety of angles, contributing to the rapid depletion. And today's relatively high prices encourage companies to use these aggressive techniques to maximize short-term profits.
With natural gas the fuel of choice for more than 90 percent of power plants being proposed, demand is expected to grow faster than the domestic supply, with imports from Canada, Mexico and elsewhere making up the difference.
Imports have doubled since 1991 to about 10 billion cubic feet per day, while domestic production has nudged up only 4 percent to 52 billion cubic feet per day over the same period.
Regions where gas once was plentiful are yielding less each year, prompting petroleum producers to push for greater access to potentially larger finds in the Rocky Mountains, the Gulf of Mexico and Alaska.
''Because companies are getting more for the gas they find, they can get smaller targets and still meet economic goals,'' said Mark Papa, chief executive of EOG Resources Inc., a Houston-based independent producer. ''But you've got to drill three wells ... to get the equivalent of one well found three or four years ago.''
In East Texas, Anadarko is drilling four, sometimes five, more wells per square mile than it would have a generation ago, said Rex Alman, the company's vice president for domestic operations. Anadarko drilled more gas wells in the first six months of this year than it did in all of 2000.
Whether oil companies gain access to federal lands currently off-limits in Wyoming, Utah and Montana will depend on the outcome of what many expect to be a brutal land battle between industry and environmentalists.
Opponents to drilling in the Rockies are worried about noise, water pollution and the damage drilling would inflict on plant and animal populations.
''Unfortunately, surface damage is not considered a cost to the industry,'' said Travis Stills, an attorney for the Oil and Gas Accountability Project, a watchdog group based in Durango, Colo.
Stills said the industry must really be worried about dwindling supplies in Texas, Oklahoma, Louisiana and elsewhere--otherwise, he said, they wouldn't be so interested in remote areas of the Rockies, where expensive pipelines would need to be built.
But the Rockies have appeal because many of its deposits are much shallower than those found in more mature basins, saving producers hundreds of thousands of dollars per well, industry officials say.
The industry also believes it can meet future demand domestically by building a pipeline that will carry massive amounts of natural gas from northern Alaska to the rest of the country.
A $75 million study of the project is being financed by BP PLC, Phillips Petroleum Co. and Exxon Mobil Corp., which control nearly all of the region's 35 trillion cubic feet of gas reserves.
Anadarko and others are spending millions of their own exploring for gas in Alaska in anticipation of a pipeline.
Said David Pursell, a researcher for Simmons and Company International, a Houston-based investment bank that finances petroleum projects, ''Unless you open up new areas, it's going to be tougher and tougher to keep the base supply flat, let alone grow it.'' |
