WSJ/U.S. Stocks: Latest Stock Market Runnup Gives Some a Sense of Deja Vu
December 3, 2001
By KEN BROWN
Staff Reporter of THE WALL STREET JOURNAL
The Dow Jones Industrial Average is flirting with 10000, the Nasdaq is up by more than a third and money managers are terrified of being left behind.
Can you guess the date?
If you answered today, you're right. But you would have been equally correct if you said May 22 or Jan. 24, the peaks of the past two Nasdaq rallies. In other words, we have seen the likes of this runup before.
Indeed, this would be the third time the Dow industrials have surpassed 10000 this year, the Nasdaq's 36% gain is two percentage points shy of its 38% spring uprising, and among professional investors, talk of downside risk has become scarcer than financing for a new dot-com. Yet during the year's previous two major rallies, in January and May, not only did the gains fade, but the market also was left lower than when the runups started.
Now, investors are buying the same speculative stocks that have disappointed them twice this year. One reason, analysts and money managers say, is that investors are more concerned with missing out on a big rally -- and perhaps the meat of the next bull market -- than with losing money.
1 Will the stock market's recent rally be sustained over the next several months? Participate in the Question of the Day.
"Usually people look at the downside and say that's your risk, but in this case the upside is the risk," said Steve Kim, Credit Suisse First Boston's quantitative strategist.
The sentiment is particularly strong because there are 20 trading days left in 2001, and money managers realize they will have no chance to catch up to their competitors in the annual performance derby.
"Everybody is playing because they think there's going to be a rally and they don't want to be left behind," said Ann Miletti, a portfolio manager at Strong Funds who bought heavily in September and has been trimming back on some big gainers, including contract manufacturer Jabil Circuit, which has soared 73% in two months.
The current rally has been building steadily since late September. All the major indexes are up sharply since their postattack lows on Sept. 21, and the month just ended saw the industrial average's best point gain (776.42 points) ever for a November and the ninth-biggest percentage gain for that month, at 8.6%, according to WSJ Market Data Group.
For the past week, the industrials were down 1.1%, or 108.15 points, at 9851.56 following an end-of-the-week rebound, while the Nasdaq Composite Index closed up 1.4%, or 27.38 points, at 1930.58. The Standard & Poor's 500-stock index fell 0.9%, or 10.89 points, to 1139.45.
The stock market has had three big rallies this year.
The first came when the Fed began its interest-rate-cutting campaign in January; the second occurred in April and May; and the most recent rally began after the market bottomed out in late September. In the first two cases, the market gave back all of its gains and more in the subsequent months.
What strikes some analysts is how closely the rallies resemble one another. All three have been led by highly volatile stocks whose outlooks are cloudy at best and whose valuations are quite high by almost any standard.
Consider Extreme Networks, a maker of computer-networking equipment. The company had a loss of $109 million during the past 12 months and earnings are down substantially from last year. Analysts, who are generally bullish on the company, have been reducing their earnings estimates, and the company trades at a price-to-earnings ratio of 275, based on estimated earnings for the fiscal year ending in June, according to Thomson Financial/First Call.
In the January rally, Extreme soared 82% from a low of $27.63 to a peak of $50.38. Then it ran out of gas, falling to $12.73. But the spring rally came and the stock boomed, almost tripling to $37.45. That didn't hold either, and the stock sank to $9.51 in September before rising 66% in the current rally to $15.83. After all that bouncing around, the stock still is down 60% for the year.
The story is similar during the most recent rally for software maker Informatica, up 183%, Emulex, which produces computer-storage equipment, up 202%, and even Priceline.com, the name-your-own-price Web site, which is up 78% since late September. All of them also boomed during other rallies this year.
Yet even investors who believe the fundamentals will improve significantly for these companies are wary. Michael Malouf, who invests in fast-growing small-company stocks at NeubergerBerman, is selling his stake in Extreme. "Extreme is extremely expensive at this point," he said.
Riskier stocks, of course, generally run ahead of the market, both on the way up and on the way down. They tend to perform well at the end of bear markets after everyone has given up on them. "Lower quality stocks do lead you out of bear markets," said Richard Bernstein, Merrill Lynch's chief quantitative strategist. "The problem is in most periods they are very cheap and nobody cares about them."
Mr. Bernstein says that despite the pounding investors have taken in these stocks this year, they are paying more for risky stocks than they are for safer names. He used the Standard & Poor's stock-rating system, which gives grades of A to the most stable stocks with the steadiest earnings growth, while more volatile, riskier stocks get lower grades. Companies in bankruptcy protection get a D.
Right now, stocks with grades of A are trading at a price to earnings ratio based on the past 12 months earnings of 22.9. By contrast, C and D rated stocks trade at P/Es of 50.7. The same trend holds true -- lower-quality stocks are more expensive than higher-quality ones -- within most sectors, if you use different valuation measures including price to sales and even if you take growth rates into account.
"We should pay a premium for safe havens and be compensated for risks," he said, adding that in one way the market resembles March 2000. Then, higher-quality stocks were cheaper than lower-quality stocks in nine of the 10 S&P stock sectors. That number subsequently fell to four in 10, but is back up to nine out of 10 again.
"One portfolio manager said to me, 'Why would I ever buy a safe-haven stock when I know there will be a turn in the economy,' " Mr. Bernstein says. "It reflects that people are very certain there's going to be a turn in the economy."
Keith Hartt, director of research at Bogle Investment Management in Wellesley, Mass., looked at the most volatile stocks in the market, in particular the 10% of companies whose share prices bounce around the most everyday. In January, those stocks surged 25.1%, in April they rose 27.5% and in October they rose 24.8%, all double or triple the returns of every major index. This group rose 17.5% in November.
The problem is as these stocks have rallied, their fundamentals have been deteriorating. If you look at the ratio of companies' stock prices compared with their sales for the past 12 months, the stocks are trading at their historical average, but sales have grown at only one-fourth their usual rate. "There's no evidence of growth resuming at this point," Mr. Hartt said. "And the market's behaving as if it's already started."
Some money managers point to the big rally in the fall of 1998 as one reason for their concern. The stock market had tumbled following the Russian debt default and the collapse of Long-Term Capital Management, wiping out the entire year's gains. But then the market soared through the end of the year, with the Nasdaq's 54% rise leading the way. "It reminds me a little bit of the fourth quarter of 1998, the Fed eased and we were really left in the dust," says Bill Church, chief investment officer at SG Cowen Asset Management.
One legacy of that period is that money managers are terrified of lagging behind their indexes or their competitors. The risk, of course, is that these managers will be so worried about trailing the indexes that they will follow them down yet again.
Cowen's Mr. Church says: "You know what I am really concerned about is we all start chasing it though the end of the year just in time for January to give us a slap in the face."
Friday's Market Activity
Home Depot rose $2.63, or 6%, to $46.65, after the home-improvement-products retailer swore it would live up to fourth-quarter earnings projections, and topped 2001 sales views.
General Motors climbed 1.11, or 2.3%, to 49.70. Late Thursday, the auto maker said that despite current tough industry conditions, it expected an economic recovery to drive vehicle sales higher during next year's second half.
Several home builders posted sharp gains, after Salomon Smith Barney boosted ratings on some names in the group. D.R. Horton added 2.01, or 7.7%, to 28.02; Centex gained 3.29, or 7.9%, to 45.19, and Lennar climbed 1.20, or 3.3%, to 37.20.
Enron, this week's major calamity, continued to deteriorate, falling an additional 10 cents, or 28%, to finish at 26 cents. Its onetime merger prospect Dynegy faded, down 3.30, or 9.8%, to 30.35.
Investors also started reviewing insurance companies that might have an exposure to the energy giant's collapse. Chubb, for example, eased 1.61, or 2.3%, to 70.06.
-- Robert O'Brien
Write to Ken Brown at ken.brown@wsj.com2
--------------------------------------------------------------------------------
URL for this Article:
interactive.wsj.com
Hyperlinks in this Article:
(1) Copyright © 2001 Dow Jones & Company, Inc. All Rights Reserved.
Printing, distribution, and use of this material is governed by your Subscription Agreement and copyright laws.
For information about subscribing, go to wsj.com
Used with permission of wsj.com |
