Barron's, October 26, 1998
Editorial
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The Thrills Are Gone
By Alan Abelson
Just like that -- the excitement's gone!
No more World Series. No more bear market. No more end of the world, or even a good slice of it. No more Monica. No more Viagra fever. Man, no wonder they call times like this the dulldrums.
Now, it's true that Monica's whatever-and-tell story was starting to lose some of its lubricious allure in the endless repetition (and the principals aren't exactly Romeo and Juliet; for one thing, there's no record of Juliet ever wanting to go to work for Revlon). Nor was the World Series a thrill a minute (unless you're into watching lions devour rabbits).
Viagra's loss of momentum has been widely blamed on such selfish emotions as the fear of minor side effects (like death) and the sadistic Puritanism of health insurers, whose motto is "pay for pain, not pleasure." In fact, we suspect, the real cause of the slowdown in Viagra's dizzying growth was the bear market.
Real men don't dally between the sheets when something as precious as their portfolio is in trouble. There's always another night, after all, but Microsoft is forever. Now that the bear market has been chased out of town by brave Alan Greenspan, who also decided he might as well save the world while he was in a rescuing mood, demand for Viagra should enjoy a rousing revival.
Absent these recent potent stimuli, for even a mild kick, we're forced to fall back on such thin gruel as the election campaign. Oh, there's inevitably the odd tidbit. A state senator has been murdered in Tennessee, and his opponent has disappeared. So far as the election goes, our money, incidentally, is on the deceased, who in a postmortem poll garnered an overwhelming approval rating from the voters for being dead right on the issues.
And of course, we can always count on New York's Al D'Amato to liven things up. Senator Al is locked in a tight race with challenger Charles Schumer, a Brooklyn congressman. Mr. D'Amato, to steal a line from Groucho Marx, speaks 12 languages, none of them English. Displaying the same mastery of foreign tongues that enabled him during the O.J. Simpson trial to effortlessly translate Judge Ito's flawless English into pidgin Japanese, the senator last week sought to salute the ethnic origin of his opponent by observing that Mr. Schumer is a putzhead.
Putzhead, for those sequestered souls who may not be familiar with the term, is a jolly Yiddish construction meaning penis, or, euphemistically, member. In calling Rep. Schumer a putzhead, Mr. D'Amato was actually complimenting him by referring to Mr. Schumer's status not only as a member of the House but a leading ("head") one.
Much to Mr. D'Amato's (and our) surprise, Mr. Schumer took umbrage (which is what politicians take when they don't take money) at the characterization as a cheap slur. Sadly, we can only assume the senator will try to repress his natural linguistic flair for the duration. That betokens a civil (read: bland and boring) campaign, just the sort that's suddenly and alarmingly in vogue virtually everywhere.
We can still hope, of course, for an outbreak of war between the Taliban and Iran or, hard as it is to imagine, Russia mismanaging its economy even more than it has so far, or one of any number of ratholes the IMF is frantically trying to plug up suddenly imploding. Or that Mr. D'Amato just can't help himself. Or that modern medicine will find a cure for Newt Gingrich's coma.
But right now, with markets rallying around the globe, there are ugly portents that we may be in for a period of tranquillity. If so, we'll just have to reconcile ourselves to the grim truth that the thrills are gone.
Can we level with you? Thanks. Okay: Deep down, we don't think the bear market has left town.
We're happy -- ah, make it, eager -- to grant that this has been one heck of a rally. And just the kind, moreover, that's dear to our heart, with the broad market outpacing the blue chips and the small-caps right up there among the front-runners. While the S&P 500 is up roughly 12% and the Dow 9% since the October low, the Nasdaq Composite, with the resurgent techs on fire, has bounded ahead an astounding 19%, while the long moribund Russell 2000 has sprung to life with a bang, racking up an 18% gain.
What's more, there's an admirable logic evident in the advance: Stocks that were mindlessly pulverized when the panic-dumpsters pulled up and unloaded have been among the strongest rebounders. We're thinking especially of some of the financials, whose only connection with toxic borrowers like Long-Term Capital Management is that they have none.
And it's true that the tone of the global economy seems a mite brighter, even if the texture remains dangerously friable. Mr. Greenspan's talk and tinkering, meanwhile, have kept the credit lines from silting up.
But though the clouds may not have burst, they've hardly lifted. Conditions in Asia and Russia and Latin America are still precarious, could still erupt into something very ugly. It's no accident, we submit, that the political tilt in Europe and elsewhere has been noticeably to the left (Germany and Italy are only the latest instances), reversing a trend long in place.
The deflationary tide running through so many of the world's economies seems certain to cause further political dislocations. Already, the busted economies and the new politics and politicians they've spawned have begun to sandbag the free flow of capital that, with all its faults, has animated economic growth and sparked markets near and far. A dumb idea whose time has come and one with more than modest potential for serious mischief.
Nor is our remarkable expansion proving immune to the chill of deflation -- global cooling -- that has enveloped so much of the planet. To tell you what you doubtless know, corporate pricing power is anemic, profit margins are narrowing inexorably and earnings growth is sputtering. There's oversupply of just about everything in the world and, as operating rates make clear, plenty of slack in our manufacturing sector. Credit may be cheap, but it's a lot less available than it was only a couple of months ago.
What this all adds up to is trouble in general and a hit to capital spending in particular.
For this brisk rally to be sustained, in short, the world has to hurry up and mend, and the U.S. economy must pick up. Frankly, we don't see those desiderata happening. Quite the opposite.
Indeed, the rally itself seems a trifle suspect. As Bob Bronson, an investment strategist with a Denver outfit called Investment Forecasting & Management, points out, "The geometry of a bear market" resembles the path of a ball boucing down a staircase -- "the trend is clearly downward, but each bounce off a lower step is larger than the bounce off the step before." He warns that to assume that larger rallies mean a bear market is ending is apt to prove "a costly mistake."
The Thrills Are Gone, Part 2
A fairly long piece of market analysis recently crossed our desk whose imprimatur, Forum Capital Markets, was alien to us. The author, however, Paul Milbauer, happily was not: In a previous professional incarnation at C.J. Lawrence, he had followed energy and written a prophetic article for Barron's on the infamous natural-gas bubble. As we read through Paul's assessment of the current investment picture-which he entitled "Everything Old Is New Again" -- we grew increasingly impressed. The overall view was shockingly sensible; the tone was refreshingly undogmatic; the illustrative stuff, highly illuminating; and the research, intriguing.
Table: Birth of a Bull
We buzzed Paul at his desk in Old Greenwich, Connecticut, where Forum Capital Markets hangs its corporate hat, and discovered that the firm specializes in convertible securities, furnishing research and execution for the institutional crowd. Paul's foray into the treacherous terrain of market commentary merely confirms that inside every analyst lurks a strategist struggling to get out.
The market, Paul feels, is significantly overvalued. High valuations, he concedes, do not necessarily a bear market make, but they speak volumes about the level of risk. The table accompanying these scribblings (which we've dubbed "Birth of a Bull") is Paul's handiwork, and it shows what the market looked like at past bottoms.
And what it looked like at those critical junctures when a bear market was ending and a bull market a-borning was decidedly nothing what it looks like now. A glance at the table reveals the striking differences in valuation. For that matter, even while it was mired in the depths in October, the market's valuation measures were wildly higher than at the end of previous drops of 15% or more: The P/E stood at 23, the sum of its P/E and the inflation rate came to 25, while the sum of its P/E and the yield on the long bond was 28. These last two measures are Paul's ingenious reply to the proposition that low interest rates justify sky-high multiples.
We're headed for a tough environment, Paul sighs, for companies that are in love with leverage, have skimpy interest coverage, are closely tied to the economic cycle and whose stocks carry overly generous P/Es. His screens turn up a number of such vulnerable concerns, among them North American Vaccine, CellNet Data Systems, Windstar, BEA Systems, Intermedia Communications, Centocor, NextLink Communications, Cross Timber Oil, Nextel Communications, Alternate Living, Skytel Communications, NeXstar Pharmaceuticals, Sinclair Broadcasting, Sunrise Assisted Living, Premier Parks, IXC Communications and Jacor Communications.
Although, he confesses, a good stock is hard to find these days, he cautiously offers a computer-generated list of companies with strong balance sheets, whose shares are priced more for reward than risk. These anointed few include Magna International, Wendy's, Fleetwood Enterprises, Pier 1 Imports, Diamond Offshore Drilling, MCN Energy and USX-U.S. Steel Group.
The essence of Paul's investment advice is: This is no time to be a hero. He urges one and all to be defensive, cuddle some cash, keep an eye out for shorts as well as longs and sell into rallies, especially the giddy variety.
Table:
Birth of a Bull
Valuations at market bottoms
(Following a 15% or greater decline in the S&P Industrials)
-Date of Bottom
-%decline from top
-PE
-PE+inflation Rate
-PE+Long Bond
October '90 15.5% 12.9 19.16 21.86
November '87 31.8 14.4 18.91 23.69
July '82 25.5 7.7 14.19 21.23
February '78 19.9 8.3 14.64 16.49
December '74 42.0 7.9 20.10 15.49
June '70 32.3 13.6 19.61 20.68
September '66 17.7 14.0 17.49 18.78
June '62 24.3 15.6 16.82 19.63
February '58 16.2 12.4 15.73 15.68
May '49 16.0 5.7 5.30 7.94
April '42 24.8 7.9 20.58 10.37
May '40 29.5 9.7 11.17 12.20
June '39 19.3 15.3 13.38 17.50
March '38 52.1 9.3 8.44 12.05
March '35 19.6 16.3 19.15 19.06
February '33 33.4 14.0 4.05 17.22
June '32 85.7 9.1 -0.41 12.61
Oct. 21, 1998 8.1 25.5 30.54 26.90
-Date of Bottom
-%decline from top
-PE
-PE+inflation Rate
-PE+Long Bond
*Using month-end closing prices
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