Don Luskin's comments from Wednesday
<Risky Business
Wednesday, January 16, 2002
Donald Luskin
Intel is pulling in its horns, and so are investors. Since risk-taking is what creates
growth, that puts the economy, and the market, in a bind.
This commentary appeared as an "Ahead of the Curve" column on SmartMoneySelect.com on January
16, 2002.
Earnings season has started with a bang. And that bang is the sound of investors taking
stocks out and shooting them — even when they surprise on the upside.
Why? Because right now we're way beyond the normal "show me the money" mentality that
dominates a typical earnings season. This earnings season it's going to be nothing less
than "show me the miracle." As I discussed in this column last week, stock prices are now
so high in relation to consensus earnings expectations that only a miracle can sustain
valuations.
For example, consider Intel, which walked into Tuesday's report after the bell sporting a
forward price/earnings ratio something north of 55. The chip giant reported a fourth quarter
in which it delivered earnings per share of 15 cents vs. the 11 cents expected by the Wall
Street consensus. But as soon as the good news was on the wire, the stock sank in
after-hours trading, losing over 3% of its value.
Intel's nice little four-cent surprise hints at a nice little recovery in the tech economy, but
should we think of it as a miracle? Should we even be surprised that there was a little
bounce-back after the temporary global shock induced by the Sept. 11 terrorist attacks?
Should that four-cent "beat" thrill us so much that we forget that the 15 cents earned in the
quarter represents a 62% drop from a year ago? Should we reach frantically to fasten our
seatbelts in awed anticipation of a glorious ascent when Intel guides revenue forecasts for
the coming quarter to somewhere between flat and falling? And should we renew our
consecration of the tech economy when Intel takes a hunk of its own money off the table by
cutting its capital-expenditure budget for 2002 to $5.5 billion, down from $7.3 billion in
2001?
In a word: no. Andy Bryant, Intel's chief financial officer, put it plainly: "We've seen no
signs of an economic recovery." Or to paraphrase Sidney Greenstreet in Casablanca,
they've outlawed miracles.
As this earnings season grinds forward, I predict there'll be more and more
disappointments like Intel — companies that meet or beat for the last quarter, but can't
guide high enough to meet investors' insatiable appetite for miracles. And after a week or
so of it, I'll bet you're going to start hearing a lot less about a "super-V" recovery from
recession.
Intel knows it already. That's why it has cut its capex budget by $1.8 billion. After all, why
should it keep risking more and more every year to build more and more capacity when it
doesn't think it'll sell more and more of its products?
In fact, if you take a dispassionate look across the markets, you'll see that Intel isn't the
only one asking why it should be taking a lot of risk right now. Investors are asking the
same thing. Oh, I know you'd never know it from today's "bear-market bubble" in technology
stocks, stocks that have been run up to valuation levels not seen since the top of the bull
market in the spring of 2000. But that will pass. My colleague at Trend Macrolytics, David
Gitlitz, has studied other smaller and less-liquid markets, markets that may reveal more
about true risk-taking propensity. Gitlitz has looked at the markets for high-yield debt, initial
public offerings and venture-capital financing — and he reports that all three indicate that
investors are still terribly risk-averse.
He points out that high-yield debt — or "junk bonds," as that marketplace for
high-risk/high-return public financing is so flatteringly called — has shown virtually no
recovery compared to its pre-Sept. 11 levels. The yield spread between junk bonds and
safer investment-grade bonds — the extra yield that jittery investors demand of junk bonds
to compensate for their extra risk — is currently about 10%, and that's twice the historical
norm.
Gitlitz notes that initial public offerings have virtually disappeared from the landscape. Last
year had the fewest IPOs since 1979, and the total amount of money raised was the lowest
since 1995. And so far this year there have been none at all. During the dot-com boom,
IPOs were seen as a riskless ticket to riches — if you could even get hold of them. But now
nervous investors won't take the risk on new companies. And underwriters won't take the
risk of sponsoring offerings that may find no buyers.
And Gitlitz also points to the implosion in venture-capital financing, the fountainhead of
entrepreneurial capitalism and the riskiest segment of our capital markets. New-venture
financing was about $35 billion to $40 billion last year, down two-thirds from 2000.
Investors are shunning risk for two reasons. First, they are simply terrified. And after one of
history's worst stock-market crashes, the first recession in a decade, and an
unprecedented attack on American soil followed by an unconventional and open-ended war
on terrorism, who can blame them? But second, and just as important right now, investors
aren't seeing sufficient rewards in the future to summon forth their courage.
Gitlitz says that the U.S. economy might register a quick end to the recession — on paper,
at least. He points out that with the fuzzy math that underlies the government's calculation
of gross domestic product, it wouldn't take much more than an end to last year's enormous
inventory burn-off to result in the statistical impression of economic growth, even if little else
changed. But he cautions that if investors' appetite for risk doesn't rebound, the recovery
will be anemic and illusory.
And that puts the economy in a real bind. Because when you cut through all the fancy
theories touted by the economists, the simple truth is that taking a little risk is the only thing
that ever causes an economy to grow. Risk is where innovation comes from. Innovation is
where productivity comes from. And productivity is where growth comes from. So no risk, no
growth.
And paradoxically, without the hope of growth there's no incentive to take risk in the first
place. Risk and growth live in a virtuous cycle whose byproduct is prosperity. And right now
that cycle is broken.
The only way the virtuous cycle of risk and growth can be repaired is by raising the
expected returns for risk-taking to the point where investors start coming out of the fetal
position, pulling their thumbs out of their mouths and rolling the dice a little bit.
One way to do that would be to cut capital-gains taxes, preferably to zero. That would
instantly raise the expected returns for all investments that would otherwise have been
taxed and coax investors back into the virtuous cycle. And, hey, it wouldn't cost anything —
the Treasury isn't exactly making a lot of money on capital-gains taxes right now anyway, is
it?
If that happened, you'd see Intel's capex budget back to $7.3 billion and more before you
could say "0.13-micron architecture." And then — then, but not now! — you'd really have
the miracle that investors are waiting for.>
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