FROM SSB today:
------------------
Monday Morning Musings - Can the Recent Rally Be Sustained?
October 15, SUMMARY
2001 * The markets recover to pre-attack levels given various
drivers
Tobias M. * Strength seen globally as military strikes galvanize the
Levkovich investment community alongside fiscal and monetary stimulus
* Anthrax scare provides profit-taking opportunity but market
struggled back
* Tech sector strength was not surprising but care should
be taken given outsized gains is some names
* Five reasons to believe in the market continuing its upward
climb
OPINION
In an impressive response to fiscal initiatives, monetary stimulus and
military action, the U.S. equity markets have rebounded smartly from the
severe losses experienced during the week of September 17th. Moreover, the
market's ability to claw its way back on Friday from an anthrax-related sell-
off was similarly encouraging. Yet, in view of the strength of the bounce
off the recent lows and, in particular, almost shocking 50%-plus gains in
various technology names, we would think that there may need to be some
settling back in the very near term.
Not only have the Dow Jones, S&P 500
and the Nasdaq climbed anywhere from 13% to 16%, the recovery has been
mimicked across the globe, with the FTSE 100 up 16% in the past three weeks,
along with a 19% jump in the CAC 40 and a 21% surge in the German DAX.
Indeed, the DAX gain was its best three-week move since at least the 1970s,
while the FTSE has not been able to string together a similar 15-session
performance in more than 15 years.
Hence, to some degree, the anthrax news regarding The New York Times and NBC
actually provided some reason for some profit-taking, in our view, rather
than any major shift, in our opinion. Indeed, a number of polls indicate
that Americans are anticipating more terror attacks and anthrax specifically
is treatable -- thus, it is doubtful that the news itself caused a major
change but rather provided a window for investors to book some near-term
gains.
Bear in mind that we believe a combination of short covering and some natural
buyers trying to keep up with moving benchmarks probably caused the fairly
sharp upturn. That, in our opinion, combined with some news that business
was not falling apart as had been anticipated by many naysayers, sparked the
rally, with news out of Cisco, Dell, and Juniper Networks generating much
better performance in the tech sector.
The strength in the technology names is not that surprising in that many
investors had mistakenly seen the tech sector as being driven by cyclical
growth only to find out late in 2000 and in early 2001 that it was as
cyclical as ever. Thus, at the first hint of cyclical economic hope, the
tech names gained alongside consumer cyclicals, capital goods, basic
materials, and financials. Fascinatingly, despite the reports of weak retail
sales numbers, investors plowed into cyclical groups, since the data, while
bad, was simply not awful. Auto sales thus far in October have been
powerful, and, while driven by incentives, suggest that consumer spending is
still alive and kicking.
Back on September 14th, we had stressed our sense that technology names would
likely do well in almost any of the three scenarios that we outlined might
evolve when the market reopened. Yet, we remain concerned that expectations
for earnings recovery for many technology names will not be borne out for
three reasons: 1) Demand will trail overall corporate profits and employment,
both of which are still headed lower; 2) Supply is now well ahead of demand
and thus margins will not bounce to the same extent as might be anticipated
due to increased competition; and, 3) The industry's growth over the past few
years was driven by nonrecurring funding capacity -- thus, it is unlikely to
be repeated.
Nonetheless, as we noted on September 24, the market adjustment of the prior
week had provided investors with an opportunity to step up and buy strong
franchises such as General Electric, Tyco, Applied Materials, Intel, Cendant,
and Siebel Systems, as well as another dozen names including industry leaders
such as IBM and Goldman Sachs. Our preference in technology was to play the
old tech area including IBM, Compaq, and Hewlett Packard as well as
semiconductor names rather than chase the New Economy tech sector leaders,
and thus we might want to take some profits in those areas given the
likelihood that demand may not rebound until 2003.
To a certain degree, some of the easy money has been made, but we are far
from sure that the rally is over. Most of the news headlines and market
gurus continue to suggest that it cannot continue due to excessive
bullishness, even though we have not met many bulls. In fact, in our talks
with investors, we hear a litany of concerns from soft corporate earnings to
terrorism's new equity risk premium and to the consumer spending impact of
job losses. Even the stimulus programs are being viewed skeptically with an
eye towards rising inflation concerns despite no sense that bond investors
are worried.
In our opinion, there are five key reasons that the rally could be sustained:
1. Earnings expectations already are very low for 2H01 and thus it may prove
to be difficult to disappoint investors in any great manner across the board;
2. Valuations are fairly reasonable based on median P/E multiples (ex-tech)
on 2002 consensus estimates;
3. Equities still look attractive relative to both bond returns and cash
returns;
4. A huge stash of money market funds (or cash) on the sidelines equaling
almost $2.3 trillion (see Figure 1 below); and,
5. Investor sentiment remains uncertain as many investors who did not
participate in the rally may feel that they have missed it, while those who
made money may think that it is the time for profits.
In our view, the big risk is that the Fed reverses course due to inflation
concerns, but with oil prices in retreat, this seems unlikely. Indeed, each
penny of lower per gallon gasoline prices adds $1 billion to consumer
spending capacity and this writer filled his tank yesterday at $1.41 per
gallon, down from near $2.00 this past winter. Hence, we see the great risks
to be some major oil supply disruptions or a major outbreak of meaningful
terrorism to undermine consumers. However, the offset to the terrorism risk
is successful special forces' operations against terrorists.
In this manner, we continue to believe that our year-end 2001 target of 1200
for the S&P 500 is reasonable as is the 2002 target of 1350, although the
going could be choppy. Furthermore, we maintain our feeling that consumer
cyclicals and financials are attractive and some capital goods names could
still be attractive as well, but we would like to see some additional
inventory-to-sales data to believe that weak industrial production has
continued to work down inventories in the face of soft sales trends, before
advising a stronger commitment to this sector. In that context though, the
combination of auto production cuts and surprisingly strong retail demand may
mean that the autos and auto component names might be still represent good
value, in our view.
Figure 1: Money Market Funds Assets As a Percentage of the Wilshire 5000
(can only be viewed using PDF format)
Source: Federal Reserve, Reuters, Investment Company Institute
Companies Mentioned:
Applied Materials Inc. (AMAT-$35.16; 1H)
Cendant (CD-$13.63; 1H)
Cisco Systems Inc (CSCO-$16.95; 1H)
Compaq Computer# (CPQ-$9.92; 1H)
Dell Computer (DELL-$24.13; 3H)
General Electric (GE-$39.00; 1L)
Hewlett-Packard Co.# (HWP-$18.35; 1M)
Int'l Business Machines Corp.# (IBM-$100.84; 1M)
Intel Corporation (INTC-$25.02; 1M)
Juniper Networks# (JNPR-$21.06; 2S)
Siebel Systems (SEBL-$20.02; 2H)
The Goldman Sachs Group, Inc.# (GS-$82.80; 1H)
Tyco International Ltd.# (TYC-$47.88; 1M) |
