Don Hays Market Comment
January 3, 2000
Now what am I going to do with all this Chili and Pork and Beans? And I
can't even get in the kitchen for all these bottles of water. To top that
off, I go in the bathroom, and what do I find, my bathtub is filled to the
brim. Is that what America is waking up to as we start this new 1000
years? I have to admit, I don't have that problem. I did catch my wife
filling the bathtub on New Year's Eve, but my giggles quickly stopped the
process, so I don't find a lot of inventory that has to be consumed before
I go back to the grocery store. But Mr. Greenspan cannot say the same.
The armored cars are visiting the banks this morning, retrieving emergency
cash from the vaults. But the huge amount of credit that has been created
will not be so easy to take out of the system.
Since the panic attacks in August-October of last year, when the Federal
Reserve had been making the first steps of reining in the massive amount of
money supply and credit that they had force-fed the system in the previous
two years of world-wide panic, they once again gave in to their fears.
During the last quarter of 1999, they once again poured it on, bringing the
12-month total of increase in Federal Reserve assets above $100 billion.
$24.4 billion of that came in the last week. I realize that some of that
was nothing more than a cushion for the banks to circumvent any run on
their banks, but this huge cushion set up the hottest run in the highly
speculative stocks in at least the last 27 years, and some believe in
history. Easy money creates easy speculation. But there is another side
to that mountain. Easy speculation creates euphoric consumer sentiment,
and the evidence was released last week as the consumer confidence
statistic was released showing the most optimistic consumer confidence
since October 1968.
As I go back to look at October 1968, I see a few comparisons that are
instructive. For one, the Federal Reserve had tightened monetary policy
for the third time on April 19, 1968 activating the "3 Steps and a Tumble"
rule that Edson Gould had popularized. But the momentum of the optimistic
speculation had refused to cave in. The Dow Jones Industrial average
continued to rally as the consumer (and investor) sentiment believed that
mighty Uncle Sam could do no wrong. It did not peak out until the middle
of November, 1968 almost 7 months later. For the last three months of that
Dow rally it really exploded moving from 870 to 980 (a 12.6% move) and the
herd was really turned on with advisory service sentiment reaching one of
its most bullish stances ever. But the advance-decline line, which had
already been miserably underperforming since the 1966 period, tried to put
on a little bounce in that peak of euphoria, but could not make a higher
high. This is very close to today's comparative action in the Dow (11.2%
in last 3 months) and the miserable advance-decline line.
But the word went out that it didn't matter what the Fed did, and became
widely accepted that the low inflation of that time was a permanent
condition. It took a while for the Fed's action to stop the train, but
when it did the next 12 months caught the economists and analysts
unsuspecting. From that mid-November, 1968 peak the Dow Jones tumbled from
its 980 peak to 630 by May 1970.
I'm sure with all the computer studies available to economists today that
they have become so much smarter than back in that long-ago antiquated
period. I'm sure analysts don't fall victim to the euphoria the way they
used to. I'm sure that Qualcomm's analysts of today are totally rational
in their new target disciplines. But despite this new wisdom and
discipline, you have to admit the comparison is interesting. Maybe
emotions don't change, regardless of how fast your modem is. For this
morning, I read in the WSJ that the economists are almost in unison saying
that this economy can not be stopped this year--another wonderful year in
the new perpetual motion machine. They say that yes, the Federal Reserve
is almost for sure going to raise interest rates, but it can't stop this
explosion in the Internet economy. With the stock market fueling the
corporate treasuries, it is okay that corporate debt expanded by 12% in the
latest year. Earnings are not that important anyway. Capital spending and
massive advertising campaigns can be financed through a new stock offering.
In fact, wages can be held down by giving all kinds of stock options to
employees, and they are not counted against their earnings with the new era
accounting rules. What a deal. What an era.
But now it is January 3, 2000. Look, I printed that number and my brand
new Y2K computer didn't crash. My brand new Y2K printer is still working.
I am so excited that I have this computer and printer that will last me at
least until the year 2999. It is now time to eat the chili. It is now
time for the Federal Reserve to go on a crash diet. It will be very
interesting to see how Mr. Gradualism Alan Greenspan acts now. Surely with
the consumer optimism so high, he can work up the courage to take a little
of the whipped cream out of the system. But you know the cake does not
taste the same without all that whipped cream. So we'll see if Qualcomm's
analyst is as bullish next year as he is this year without the extra
whipped cream.
Last Friday we copied you on a study that Peter Eliades had sent me,
talking about the "00" years in the stock market. Even though I have
always been highly skeptical of these decennial patterns, I am more
interested this year since it helps to substantiate what my asset
allocation model is telling me. (Ha! Ha!) Hopefully you have last week's
report that I totally copied his comments, but the gist of it was that in 7
of the 10 "00" years, the market hit a significant peak in the first two
trading days of the year. The only three that it did not, occurred in the
years when the markets' close of those two trading days did not move to a
new high above the previous month's highest closing day. So we'll be
watching the next two days close to see. Any positive close today would do
it, with the Dow Industrials, the S&P 500, and the NASDAQ composite all at
record highs on the last trading day of 1999.
Fundamentally what do we find as we start this year besides a runaway
credit generation that must be slowed down now that Y2K has come and gone?
We find the lowest unemployment since that same period of 30 years ago; we
find the lowest unemployment insurance claims since 1973. We also find
that real consumer spending is up 5.4%, while real disposable income is up
3.6%. Savings rates are in negative territory, with the robust consumer
spending obviously being financed by the real estate and stock markets.
Yes, the inflation rate is still relatively low, but coming off of massive
help in the last two years from a very weak international economy and low
producer prices. But that is ending, and now for the first time in a long
time we are seeing the increase in producer prices climbing above that of
consumer prices. This historical study shows that in the past this has led
to a very restrictive Federal Reserve and recessions.
As Paul Volcker has said, this world economy is so dependent upon the
continuing bullish action of about 50 stocks. So those optimistic analysts
better be right about the perpetual motion machine that Alan Greenspan's
buoyant money and credit creation has produced. Alan Abelson in Barron's
had a very interesting chart in this week's column. He reproduced the
price-earnings ratio for the NASDAQ composite. It was only updated through
November 1999, but extrapolated through the end of the year. It is a chart
that you have to take with a grain of salt, but only a grain. It shows the
price-earnings ratio for that over-the-counter group of stocks has just hit
the 200 level. And we thought the p-e of the Japanese market was high back
in 1990. I guess we showed those Japanese that we could blow bubbles up
bigger than they could. Of course, it has taken them 10 years to remove
the sticky remnants off their red faces, and they still don't have clean
faces, so I wonder how long a burst US bubble would take to clean up.
But I have to admit, the bubble is in only in a small remnant of stocks.
I have always admired much of the work that Value-Line does in this regard.
I know many on Wall Street like to make light of some of Value-Line's
quantitative approaches, but up until a few years ago when the on-line
services made IBES and First Call's earnings so easily accessible, I would
catch the analyst sneaking over to look at my Value-Line reports as they
came up with their estimates. Arnold Bernhardt, and his successor research
efforts, have been ingenious in their methodology. For many years I have
always watched their valuation measure closely to keep with what is
happening to the typical stock. So now as I see the 200 p/e on the NASDAQ
composite, and the 33.42 for the S&P 500, and even the 24.6 for the Dow
Jones, I know that these extraordinary valuations are the result of only a
few stocks. Since almost 70% of the stocks on the New York Stock Exchange
were down in 1999, something is very much out of kilter. Value-Line helps
to put this in perspective. They print every week the "median" price
earnings ratio for their 1700 stock universe, based upon projected earnings
for the next 6 months, combined with those reported in the last 6 months.
It is interesting that this week's edition shows this "median" p-e is now a
very respectable 14.4. In comparison, the high level in recent years for
this statistic was 19.7 on April 22, 1998. Twenty-six weeks ago, it was
16.9. This gives you a very clear indication of the bear market that has
already impacted the vast majority of stocks.
But just like in November 1968, it ain't over 'til it's over. It took a
while to slow down and finally stop those rampaging, big-cap stallions, but
once it did, the stallions were close to an exhaustive death, and it took
years for them to run again.
It is a definite understatement, but last year was a year that I am glad
to see come to an end. It wasn't bad. My asset allocation started the
year in a fully invested posture, but as the end of the first quarter
witnessed an explosive move, it started to raise defensive cash and bond
positions. In the strategic category under the heading of "long-term
investor", it ended the year with only 50% allocated to stocks. When I
look at the portfolios that I manage I find some tremendous gains in some
of the issues that they hold, i.e. Texas Instruments, Human Genome
Sciences, Nortel Networks Corp, Dayton Hudson, Amgen (recently sold), and
Cisco Systems. The gains in these stocks more than made up for the
miserable performance in the portfolio in the stocks such as Duke Energy,
Fannie Mae, First Tennessee National, Fleet Financial, and Burlington
Northern. I recently bought put options against the high-flyers. But even
with the positive performance numbers, I consider 1999 a very tough year to
be an investor, and feel very confident that most of you will concur.
As you are fully aware of, I expect this year to start out on a very
negative note after the first few weeks are out of the way. For the next 2
to 3 years, I expect the market to be highly volatile, very similar to the
years from 1968 to 1974. Despite the volatility, there should many
opportunities to invest, but unless I miss my guess the volatility will
produce more short-term opportunities than long-term, especially in the
big-name angels of today. But under the surface, as depicted by the low
p-e ratio on the Value-Line median stock, there will be many gems
unsurfaced that are simply too attractive to pass up. So we look forward
to the next few years when we expect market timing to become the most
important investment tool to your investment survival. |
