Worldly Investor News, 08/21/2001 08:08
Is the Bear's Picture Starting to Fade?
by Mitch Ratcliffe
Continuing a theme from last Thursday's column, let me begin by pointing out that the idea that the economic downturn will last forever has really started to catch on. There is no better sign that this bear is on its last legs.
Articles and on-air commentary have begun to argue that the Federal Reserve's rate cuts have been ineffective, even though the requisite amount of time for the effects to be seen hasn't passed. The argument is that the U.S. is about to follow Japan into a decade-long recession. After months of industrial wipeouts, the economy will not simply leap to its feet and dance to new highs. There are still layoffs and reorganizations to come.
But there are signs of improvement in the midst of the continuing correction. And it is irrational to say the economy will remain stuck in low gear forever because the Fed's action early in the year hasn't driven a recovery in less than eight months. The Fed cuts only reached a level close to the rates last seen during the recession of 1991 in June?two months ago?yet we've seen four months of improvements in the Conference Board's Leading Economic Indicators, inventories are generally at ideal levels to drive solid demand for components, and there is no sign of a Japanese-style deflation.
Investors impatient for a change of pace are wringing their hands and deciding the recovery will never come. It's as silly as the idea that predominated during the bubble, that productivity and profit would never stop growing at 30% a year.
How Long to Normal?
The real concern should not be whether we are entering a permanent downturn, but just how long it will take to return to "normal" growth in earnings and share value. If the IT spending downturn was the crest of an economic tsunami, the trough of unemployment that follows has the potential to impact consumer spending, which has remained strong.
I'd argue that many of the 150,000 people laid off during the last year by IT companies have taken an extraordinary opportunity to pursue leisure on accumulated savings. There was a shortage of almost a half-million IT workers in early 2000; almost all the people that wanted to find new jobs have done so and the rest have taken extended vacations.
If my position is correct, the savings that supported many workers will begin to run out in the next quarter or two and they will return to work; few will end up on unemployment. Except for some notable exceptions, like Ford (F), there hasn't been the same kind of layoffs in the "old" industries, and we'll not likely see a major slump in consumer spending as this unemployed IT population comes back to work.
If you draw a trend-line on a chart of the Nasdaq Composite from 1990 to today, you'll find that we are trading just below where we should be over based on normal growth over the past 12 years.
The 1998-2000 expansion was the outlier while the overall value of the composite index has continued to accrue on a relatively straight line, even to the present day. If you'd looked into the future in 1996, based on previous performance, it would have been reasonable to believe that as of August 15, 2001, the Nasdaq would be trading at between 2,200 and 2,400.
Pipe Dreams
Something really unusual would have had to have transpired in the economy in order to support a Nasdaq 5,000?we can see this in retrospect, but the dream was oh so sweet while it was going on.
Many companies did experience truly extraordinary growth in the years since 1997. Cisco Systems (CSCO), for example, earned $1.04 billion on $6.4 billion in sales in fiscal 1997. This year, it lost $2 billion (mostly due to write-offs of exorbitant prices paid for acquisitions in 1998-2000) on sales of $22.2 billion.
Likewise, Microsoft (MSFT) grew net income from $3.5 billion on sales of $11.9 billion in 1997 to $7.3 billion in earnings on revenues of $25.2 billion in fiscal 2001. Granted, a lot of companies have come and gone out of business, some spectacularly, but among the quality companies in the IT industry there has been a dramatic increase in real returns on capital.
Okay, so if the market is currently below its "normal" value, and companies are generally earning more than they did in 1997, why isn't the Nasdaq trading above 2,000?
Fear Breeding Fear
Simple. We're afraid. Very, very afraid. If anything, the market is a reflection of investor confidence and not straightforward value?because there is no single calculation that explains fair value, rather we adjust for a variety of contending forces that reflect different opinions about value.
The fear is coming out in articles and comments on the financial news channels that indicate analysts and traders are feeling hopeless. It's the diametric opposite of the so-called irrational exuberance of the bubble era.
Now, I remember one day in late January, 2000, when I really began to believe we would see Nasdaq 10,000 within a year?I even remember saying something about taking bets on when the Nasdaq would exceed the Dow Jones Industrial Average on air at ON24. That was the day I should have started selling.
Now that the market has given into despair, it is time to buy opportunistically, but not to rush in because negativity leads to lighter volume and, therefore, more volatility that can cost you dearly in the short term. We'll know the downturn is over after it is over, for now, all we can do is try to draw on what we've learned from the expensive lessons the market has taught us since March, 2000. Based on what is happening, it seems like the bear is stumbling.
Ratcliffe is a managing director of The Petkevich Group, a San Francisco-based merchant bank serving carefully targeted segments of the biomedical and networking technology industries. He is also a longtime executive and investor in the technology industry. Ratcliffe's insights and analysis of the high-tech industry will appear twice each week. MSFT and CSCO are holdings in The Wired Portfolios, model portfolios Ratcliffe manages through a subscription. Positions can change at any time. |
