To follow your lead with information. Just received this e-mail.
SURVIVING THE CORRECTION
By Joe Arena
Many investors have never experienced a bear market. Regardless of
which definition of a bear market investors choose to accept, current
market conditions are treacherous, especially for high tech investors.
In response to many of the e-mails we have received at The High Tech
Arena, here are some general guidelines which may help to quell the
pervasive fear that exists
The current market volatility can exacerbate the pain many are feeling
right now. At such times, it is prudent to forget what the market is
doing, and focus on analyzing the fundamentals of the individual
companies you are invested in. Many investors do not realize that
stocks move in the long term for one reason, and one reason only. The
reason is earnings growth, and that earnings growth is reflected in
stock prices over time. It behooves all investors to strengthen their
conviction of a long term time horizon by determining what impact
industry fundamentals will have on the earnings visibility of the
companies they have invested in.
1. For example, if the Nikkei hits a twelve year low, that does not
alter the fact that according to Cisco's annual report, 7 people every
second gain access to the Internet, or that only 3% of the global
population currently has access to the Internet, or that 50% of the
world population has never used a telephone. There is blood in the
streets in Indonesia, but there are 1.2 billion people in China, where
spending on information technology is forecast by IDC to grow over 27%
next year, and the installed base of computers there is only 11
million. Dell Computer does 20% of its business in Asia, but 80% of
its manufacturing costs are in Asian currencies. Japan is mired in a
recession, but sales of Windows 98 are exceeding expectations. This
is the kind of information to focus on during market corrections, not
the gyrations of foreign stock markets which are driven by short term
psychology that will have only modest bearing on earnings of such
companies as Microsoft, Cisco, and Dell. Certainly, given the
historically high p/e ratios of these stocks, they will recede to more
traditional levels of valuation. Regardless of the stock price,
whether it is overvalued or undervalued, the fact remains that their
businesses are strong, and the guidance given by these companies has
not changed.
2. There is always something to worry about in the market, and if you
get caught up in the multiple macroeconomic factors which create
uncertainty and risk, you will never reap the gains of successful long
term investing. Market timing simply does not work over the long
term. The same emotion that scares people out of the market acts as a
double edged sword, and precludes them from buying back in until the
market rallies substantially. Everyone has the intellect to dollar
cost average in quality growth companies, and that is what investors
should be doing now. The problem is, many do not have the stomach to
execute this strategy. It is easier said than done when dire
predictions of global depression and Dow 4600 abound.
3. How, then, do we best separate the emotion from the intellect,
which is the single most important factor in achieving success in the
long term?
a.) Pay no attention to analysts or talking heads on CNBC whose
opinions are worth exactly what you pay for them.
b.) Do not look at the net worth of your portfolio to determine how
much you are down from the highs, this will only increase the
probability that you will channel this emotion into action which will
hurt in the long term.
c.) Remember that you are buying a business, not a stock. If the
fundamentals of the business that you are invested in remain intact,
do not change your long term plan on the basis of market volatility.
d.) When pruning your portfolio, do not pull the flowers and water the
weeds, do exactly the opposite.
e.) When the market is going higher, it is human nature to extrapolate
this trend and expect it to continue. The same is true for a
declining market, and fear is always a more powerful emotion than
greed. Thus, although markets usually get overdone on the upside,
they get even more overdone on the downside.
f.) Recognize the proclivity to behave differently in a market
environment than you had planned. For example, if you were told at
the beginning of 1998 that the market would be down 15% this year, you
probably would have responded that this would be a normal, healthy
correction. However, since we got overdone on the upside before
correcting, the current decline seems more severe, when in reality it
is a reasonable decline within the context of a secular bull market.
Thus, investors are more likely to acquiesce in the current mentality
on Wall St., where bad news is cataclysmic, and good news is bad news.
g.) Always bear in mind that the market is a discounting mechanism,
and is now in the process of reflecting the worst case scenario. When
it becomes apparent that a global financial Armageddon will not occur,
bad news will be ignored, and good news will create violent rallies,
and the correction will end.
h.) As previously mentioned, investors should never try to time the
market and pick a bottom.
However, there are some signs that in terms of time (not necessarily
the level of the DOW) that we are approaching the end of this
correction. When quality companies like Cisco are downgraded after
they have already declined 30%, this is an indication. When
downtrodden stocks like Applied Materials and Micron Technology fail
to decline on more bad news, this is a positive. From a more
anecdotal perspective, I think back to the commercials that CNBC aired
right before the crash of 1987, and how this changed the next day.
Thus, until they stop airing that ridiculous commercial about how
buying a particular company's software enabled an investor to achieve
over 200% returns, we might not have seen the bottom. Finally, when
people stop e-mailing me with questions about quitting their job to
day trade, I will be confident of a bottom.
4.) Stick to tried and true tenets of high tech investing. First and
foremost, critical mass and economies of scale will provide those
companies who possess it with a tremendous, almost insurmountable edge
in the rapidly evolving PC, Software, Semiconductor, and Networking
business. Do not diversify into smaller companies which you perceive
to be potential gold mines, they turn out to be land mines more often
than not. Trying to discover the next Microsoft, Intel, or Cisco has
a very unfavorable risk/reward ratio.
Second, buy only those companies which have shown over at least a five
year period that they can sustain 25% earnings growth. Third, buy
only those companies which have developed a superior business model
which competition has found it difficult, if not impossible to
emulate. Fourth, when there is a war going on, buy only those
companies which are selling the bullets. Fifth, buy only those
companies which have shown a unique ability to reinvent their business
model and execute it every few years.
Thus, The High Tech Arena continues to recommend that the two
companies who best fit this philosophy are Microsoft and Cisco. For
the benefit of our many new readers, we should reiterate that for
aggressive investors, our key investment premise remains
"diversification is a hedge against ignorance." As a result, we
believe in concentrating our assets only in our best ideas. However,
for those who desire a more diversified high tech portfolio, we
continue to believe the following companies are attractive investments
for those with a 5 year time horizon: Dell, Lucent, Texas Instruments,
Merck, and Pfizer.
In conclusion, remember that in a correction, everyone loses money.
The goal is to live to fight another day.
THE HIGH TECH ARENA
Joe Arena
JRArena@aol.com
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