THE ROARING 2000'S?
_________________________________________
By John Mauldin
dailyreckoning.com
Please consider the following excerpt from Dent's latest
special report, "What Happened on the Way to the Roaring
2000's?":
"Just as the 'tech wreck' in the newly emerging auto
industry was a golden opportunity for investors 80 years
ago, today's investors have the greatest buying opportunity
of this entire economic boom, perhaps of a lifetime, right
now...Our most likely forecast shows that the Nasdaq could
reach 13,000-14,500 by the top of this boom, 6 or 7 years
from now, which is more than ten times from its low of 1114
in October 2002."
Let's see...the Nasdaq at 14,500 by 2010? In my mind, the
above forecast could use a large dose of reality.
Let's rewind the tape to late 1999. I can't remember
whether it was Las Vegas or San Francisco, but both Dent
and I were speaking at a large investment conference. I
spoke first, telling the some 3,000 attendees there was a
recession in our future and the market was headed down.
Small (but polite) applause at the end of the speech.
Dent spoke a few minutes later, making fun of the doom-and-
gloom speakers who were on the podium earlier. We just
didn't get it, he said. He then showed us lots of charts,
which clearly demonstrated the markets and the economy were
going nowhere but up. Technology was in its innovation
stage, ready to explode. He quoted Schumpeter. The
performance of Harley-Davidson was the clincher. Lots of
(very enthusiastic) applause.
Fast forward to today. There has been a small bump on the
road to the Roaring 2000s. Dent tells us that has merely
slowed things down, but now we are back on track. Starting
with this year and going into 2004, the consumer is coming
back. Technology is once again going to drive the markets
to new heights. Climb on board.
Let's examine his arguments and then see the logical and,
in my opinion, absurd conclusions.
Dent points out that GM dropped more than 75% from late
1919 to early 1922. GM then went on to rise more than 22
times at its height in 1929. At the time, automobiles were
the 'new, new thing.' Even with a shakeout of automobile
companies, which saw many fail, the market still
experienced a boom. Coincidentally, we are having a
shakeout of technology companies today.
He then overlays the chart of GM from 1912 to 1922 with the
chart of Intel from 1992 through 2002. Again,
coincidentally, they match.
Then, we leap to the conclusion that since GM went up 22
times after its crash, the technology markets are poised to
do the same. Quote: "We fully expect a generation of
technology giants in today's new economy to parallel GM's
spectacular rise. Who wouldn't leap at the chance to see
their investments grow as much as 22 times in the next 6 to
7 years?"
He begins Part Two of his report by telling us that the
Internet, mobile phones and broadband are going to drive
this explosion. He shows the "S" curve for these
innovations. This "S" curve denotes the very sound and
reasonable theory that innovations (cars, phones, TV,
electricity, railroads) start out slowly, then slowly rise
until the point where their growth is dramatic, often
changing the entire economic structure, until the growth
flattens out as everyone adopts the technology.
Dent is right about the future growth of these
technological innovations. They will grow dramatically. But
will they drive the Nasdaq to grow 10 times in just a few
years? That is where we part company.
There are some very large differences between 2002 and
1922. First off, in 1922, the stock market was coming off a
decades-long bear market. The S&P 500 in 1921 was almost
exactly where it was 20 years earlier...investors had
actually seen a compounded negative 1% growth for the 20
year period. In short, there is no comparison between the
value of the market in 1922 and 2002. We are talking
historical extremes. Dent is effectively suggesting that
the next bull market is going to start from the highest
valuations in history.
Dent also tells us that: "[The] transformation of the
Internet will accelerate the emergence of the bottoms-up or
consumer-driven network corporation...This revolutionary
business model will usher in a new era of productivity just
as Alfred Sloan's new corporate model at General Motors did
starting in the early 1920s."
The problem is that so far this decade, the impact of this
increased productivity has, arguably, not been a net
positive. Instead, corporations are using the new
productivity to lay off employees. Further, the Internet is
making it possible to send jobs to lower cost countries
like India and Ireland.
The extent of the productivity ushered in by the Internet -
and certainly its future growth - is also in question. In
his HCM Market Letter, Michael Lewitt aptly summarizes a
recent article entitled "IT Doesn't Matter" by Nicholas G.
Carr in the Harvard Business Review:
"'[T]here are many signs that the IT [Information
Technology] buildout is much closer to its end than its
beginning.' Among the reasons: First, IT's power is
outstripping many of the business needs it fulfills.
Second, the price of essential IT functionality has dropped
to the point where it is basically available to anyone.
Third, there is more than enough fiber-optic capacity to
accommodate further build-out."
Besides, it is all well and good to choose the chart of GM
to compare to Intel. But that's 20-20 hindsight, isn't it?
In 1922, there were scores of automobile companies which
did not make it until 1929. If you had picked one of those,
the comparison would not look so pretty.
Even if there were numerous small tech companies to pick
from, which all happened to grow ten times over, their
statistical impact upon the Nasdaq would not be that great.
To account for the type of growth Dent is projecting, we
would need to see scores of the largest companies grow not
ten times, but 20-30 times or more to make up for the
companies which will not grow more than GDP plus inflation,
or about 50% (at best!), over that time.
These is where Dent's argument really hits a wall. Today,
June 18th, the Nasdaq is at 1668. For the Nasdaq to grow to
13,000 in 7 years, it would have to do so at a compounded
growth rate of 29% every year for seven years. If it
reached his upper target of 14,500 in just 6 years, the
compounded growth rate would be 36%! This means a doubling
of the Nasdaq every two years!
Meanwhile, the P/E ratio of the Nasdaq is in nose-bleed
range. The Wall Street Journal recently reported the
trailing 12-month P/E ratio of the Nasdaq 100 at 227, based
upon reported earnings. Compare that figure to the
estimated P/E ratio for the next 12 months - 36. The
Thompson First Call estimate is even lower: 32, based on
pro-forma earnings or EBBS (Earnings Before Bad Stuff).
For Dent to be right, earnings would have to grow over 30%
compound a year for the entire Nasdaq index for seven
years. I am not even going to bother to check the record.
There has never been a time when a major broad-based index
has seen average real earnings grow 30% a year for seven
years.
Either that growth happens, or the genuine P/E ratio will
have to get even worse. It will have to rise to levels that
will make the last Nasdaq bubble seem like a blip. Can it
rise to 500? Will investors forget so soon the last bubble?
Looking at the problem in another way, Dent is suggesting
the market cap for the Nasdaq will be more than the entire
GDP of the United States in 7 years. Depending upon where
you start and finish, he is suggesting growth to well north
of $15 trillion for the total worth of the Nasdaq market.
Microsoft is currently 10% of the total Nasdaq market cap.
Will Microsoft grow to a market cap of $2 trillion? Will
Cisco be worth $1 trillion? Can Intel rise to $1.25
trillion?
For Dent to be right, those companies would have to rise to
such levels, and scores more would have to rise along with
them. If these companies do not grow to such levels, then
which companies will? To get to $15 trillion, you have to
have some VERY large companies in the mix. We are talking
companies of a size and scale which dwarf anything we have
today, or even at the height of the Bubble.
I won't even touch overcapacity in the technology world
(e.g. the huge amount of excess fiber), which will hold
down growth and profits, the coming turmoil in telecom from
the WorldCom debacle, the massive investment that must be
made to build out the broadband world, etc. etc. This is
not the stuff from which steady and historically high
profit growth will come.
Sincerely,
John Mauldin,
for The Daily Reckoning
P.S. Despite these realities, a large number of people
continue to follow Dent, as his books and writing are
compelling. It seems so logical: the large number of Baby
Boomers means more consumer spending until they retire.
This will foment unprecedented growth in both the economy
and the stock market. Look at the charts. I am sure Dent is
well meaning and sincere. But his math, not to mention the
logic, is simply AWOL in these reports. |
