Big Bull:
Below is the latest market commentary of FORBES columnist Martin Sosnoff. He has been EXTREMELY ACCURATE for many years and his record is as good as anybody's (well almost). Note that his outlook now is very different than Wallenchuck's. Expects the Dow to be lower in 2005 than it is today because he sees earnings at or near peak levels for most sectors whirl interest rates are headed higher.
Of course OS is very different. Far from being near a peak. earnings are still at trough levels. So the OSX can go back to its old high if oil prices stay up even if the overall market goes nowhere. But the OS outlook is the exception, not the rule.
Market Trends
Forbes Executive Compensation Database
Dow 10,000—in 2005
By Martin Sosnoff
A COUPLE OF YEARS AGO, I wrote that Dow 10,000 by the year
2000 was a shoo-in because of rising earnings, low interest rates
and low inflation (Mar. 24, 1997). This potent combo is still with us.
But I'm not about to ratchet up my prediction, because now the
market is priced for perfection in an imperfect world.
The assault on Mount Dow's summit—yes, it's a summit or close to
one—was instructive. Financial services stocks like Citigroup and
American Express broke out, and then a rebound in depressed oil
properties like Exxon and Chevron put us over the top. Basic
materials plays like DuPont and Union Carbide were pulled along, so
long-suffering value players may get their day in the sun. But
growthy nondurables like Coca-Cola, McDonald's and Procter &
Gamble remain wishy-washy, and formerly unassailable growth
stocks like Microsoft, Wal-Mart and Pfizer are under attack.
Brokerage stocks are at 20 times earnings—more than 3 times book
value—and inherently volatile. They've rarely sold higher. (The
exception is Charles Schwab, trading at an unspeakable Internet
valuation.)
Who will be left to buy General Electric at 30 times next year's
expected earnings, Wal-Mart at 40 times or Cisco Systems at 60
times? Even the cash flow into mutual funds—every bull's favorite
fallback—has been unimpressive recently.
More broadly, the tortuous verbiage of Internet analysts rings
hollow. Yes, the industry is in its take-off stage. But capitalizing
Priceline.com at $17 billion in such a low-margin auction business is
a flight from reality. Yahoo may be the leading Internet portal, but it
trades at 100 times predicted revenues, not earnings. Analysts
rationalize this anomaly by saying Yahoo could achieve 90% gross
income margins à la Microsoft. You want that bet? Take it. It's no
coincidence that all big deals for Internet properties—At Home's
buyout of Excite; Barry Diller's bid for Lycos—are exchanges of
paper. Nobody would part with hard cash for these properties.
Based on profit growth, the market is
20% overvalued-and don't let fancy
balance sheets snow you.
As for the economy, corporate earnings look healthy this year, but
it's hard to imagine the even-lower inflation and interest rates that
would help valuations. If OPEC sticks together, oil at $16 to $17 per
barrel will add 20 basis points to the Consumer Price Index. You can
make a case that the Federal Reserve will tighten credit around
midyear if annualized GDP growth exceeds its projected 2.5% to
3%. An overpessimistic Fed misread the economy when it lowered
rates back in October, and board members aren't happy about it.
Just read their notes.
Academics put the long-term trend in corporate profit growth at no
more than 4% per year, not the 7% needed for dividend discount
models to justify current stock prices. The S&P is 20% overvalued
using this admittedly dry analysis. And don't let fancy corporate
balance sheets snow you. If you account correctly for stock
buybacks made with borrowed money (even IBM does it) and option
grants that obscure salary expenses, you get down to 4% profit real
fast unless the economy zooms.
As for those resurgent value stocks, profit margins for many
industrials are near their peak, not at depressed levels. It's true for
General Motors, Dow Chemical, Caterpillar and conglomerates like
DuPont and GE. The only properties in the Dow Jones industrial
index with depressed earnings are Boeing, Union Carbide,
International Paper and Eastman Kodak. Where is the leverage to
propel the Dow's earnings?
The Dow pierced 1000 back in 1972 during a comparable frothy
interlude. Then came the horrendous recession of 1973-74 (OPEC
induced). The Dow touched down at 608 in 1974, 40% below its
peak and yielding more than 5%, and then took eight years to climb
above 1972 heights. In the meantime, commercial real estate values
fell off the page and the country suffered vicious inflation in
everything but stocks and real estate.
The Dow today has outgunned even 1972's valuation extremes.
When I say 10,000 in 2005, I'm not suggesting that you abandon
the market. Be very selective, picking up the strongest companies
that are relatively underpriced. IBM (even after its recent run-up),
Cigna Corp. and Chancellor Media Corp. fit that bill now. Let's give
ourselves some room for wars, economic cycles, Third World debt
and our own stretched equity valuations. Enough is enough.
Martin Sosnoff is chief investment officer of Atalanta/Sosnoff
Capital in New York and author of Silent Investor, Silent Loser.
E-mail: mts@atlantasosnoff.com
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Read more:
By Martin Sosnoff
Investment Columnists
Market Trends
From May 17, 1999 Issue
May 17, 1999
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