Some perspectives on bear markets.
Although each cycle is different, there are some reasonably consistent patterns within bear markets. Small cap stocks tend to break first due to their limited liquidity, perceived riskiness and (perceived) greater economic vulnerability. During the ensuing "flight to quality", the big cap names initially hold-up, but then follow their small-cap brethren down until panic reaches a crescendo and stocks get completely washed-out.
During the bear market, pundits generally come out of the woodwork pontificating as to the impending end-of-the-world, economic apocalypse, inappropriate near-fornication events (INFE) and political crisis. Since it is almost entirely irrelevant economically, I am very much encouraged that Clinton's INFE has had so much impact on the market because it suggests that the market had substituted fear for reason and, furthermore, that there are some extreme pockets of undervaluation resulting from the associated panic.
Within this context, let's get a grip. What is a publicly-traded corporation and how do you value it? A corporation takes public capital and combines this with some economic activity the end product of which is supposed to be earnings. Think of earnings as the coupon payment of a bond and the stock price as the principal value of the bond. Unlike a bond, the principal value of a stock is not predefined and, also unlike a bond, the coupon payment (i.e. earnings) can and will vary over time. Now, everyone understands how to value a bond...you look at its duration and its riskiness and you price it to yield some premium over risk-free assets (like Treasuries). From this relationship, it is obvious that lower interest rates will make a bond's fixed coupon payment more valuable (which is why bond prices move inversely to interest rates).
Over time, stock prices are driven by the IDENTICAL analytical process. In a panic, investors begin to question whether the coupon (i.e. earnings) will grow, grow fast enough or disappear altogether. Therefore, stock prices are far more volatile than bonds. On the other hand, since bond coupons NEVER grow, but corporate earnings tend to expand over time, stocks ALWAYS outperform bonds over the long-term.
Today we are faced with profound economic uncertainty, and some investors are worried that corporate earnings will decline or even disappear. Coming at a time when earnings expectations were too high to begin with, this change in investor sentiment has had a profound and obvious impact on stock prices. The problem is...virtually ALL stocks have declined...even the ones whose earnings are likely to expand regardless of the Asian crisis. But, that's only part of the opportunity. Soon the Fed will likely reduce interest rates. This event will (a) partially assuage investors' concerns about a global recession, (b) increase the value of corporate earnings and (c) substantially increase the value of GROWING corporate earnings. Think about it this way. If earnings are discounted at a 10% rate, then $1 in static earnings would be worth $10; the same dollar discounted at 6% would be worth $16.67 and the same amount of earnings discounted at 5% jumps to $20. PE multiples reflect this discount mechanism adjusted for the anticipated future growth in earnings. During the 1973-1974 bear market, a combination of very high short-rates (due oil-price induced inflation) and declining corporate earnings, wrecked the equity markets. Today, while we have earnings risk, interest rates are low and declining...so the current situation is vastly different from 1973-1974.
So what? I think Qualcomm's earnings, starting with the September quarter, will begin to demonstrate rapid and consistent growth. Investors seem to be missing the fact that infrastructure has reached critical mass, that the manufacturing problems from the first half are history, that royalties are expanding as are handset and ASIC sales. The company's dependence on Asia is lessening, even as Korea's wireless markets continue to grow and the Japanese market expands. I believe that companies with QC's growth opportunity will be something of a scarce commodity over the next year, so I think that QC is likely to command a premium PE multiple on the $3.00/shr that I think it will earning during FY99. As investors, we need to step back, separate fear and emotion from business economics, and allow QC's growing "coupon" to work for us.
Do not lose faith at this juncture Maurice!
Best regards,
Gregg |
