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Strategies & Market Trends : Galapagos Islands -- Ignore unavailable to you. Want to Upgrade?

To: X Y Zebra who wrote (9749)	10/27/2002 12:44:43 PM
From: X Y Zebra	Respond to of 57110

This post goes onto more detail on... the effects of unfunded pension liabilities acting as a "glass ceiling on stock market valuations" It has a "sober but balanced" view of the problem Message 18161135 The closing of that post.... The Glass Ceiling The large indexes like the NASDAQ, the DOW and the S&P 500 are populated with the largest companies in the investing world. The technology companies are going to have to start expensing their options or paying their employees more, while fighting a tough competitive environment. Many of the largest Old Economy companies have serious pension funding liabilities. These two "accounting" issues are a glass ceiling to earnings growth. Before we take into account deflation, competition from China and the rest of the world, over-capacity, debt, consumer exhaustion and of host of other issues, companies are going to have to deal with these accounting issues. I fully recognize that there are some companies in the S&P 500 which do not have any of the above problems. There are lots of smaller companies which don't fall into the category. But enough of them do that it will make large cap index funds severely under-perform the rest of the market. Pension/endowment funds who slavishly follow Modern Portfolio Theory and who think they must have some exposure to every part of the market will create even more problems for themselves. The accounting changes will set a new bar. The earnings bar that Standard and Poor's suggests is now appropriate is around $20 for the S&P 500. If you can assume even 10% earnings growth, which would be historically very high, it will take seven years to get back to $40. If you take the historical average P/E ratio of 15 you get an S&P of 600 in seven years. Let's say we all forget history and take it to a ratio of 22. That puts us where we are today. This is the Glass Ceiling I referred to earlier. It is earnings, pure and simple. Investors are not going to come back into the market until they think earnings are going to grow to levels that justify current stock prices. As more and more investors see these new and lower earnings estimates, they are going to exit until things improve. When new accounting standards are actually adopted, it is my bet that investors will take them seriously. And the standards will seriously lower reported earnings. And this is going to cause problems for index funds. Get out of them. Use this rally as an exit ramp. Optimists will write and say that investors will ignore the new rules. They will continue to look at pro forma earnings. They will continue to listen to Wall Street analysts. Who cares about options? Pension funding will be a non-issue when the market comes roaring back will once again. My response is that they are about 90% correct. Many investors will grab onto any life preserver that lets them think their portfolios are going to come back. They want to have the retirement they once thought they had. But over time, as earnings do not grow rapidly, and as analysts continue to be wrong, as the new standards become accepted in the marketplace, more and more investors will lose the faith. That hope of a return to a bull market and a comfortable retirement is why bear markets take years to finally end, and not months. It will take at least two more recessions before investors finally give in and we see the bottom of this one. And for that we should be grateful. If the Dow went to 4,000 next week, we would be in for a severe recession or even depression very quickly. Because things will drag out for years, we will "enjoy" milder recessions and a Muddle Through Decade. Because you understand what is happening, you can adjust your portfolio accordingly, and do quite well in the meantime. But I feel sorry for those other guys. The problems I described above are those of mostly large companies and a few penny stocks like Lucent. There are small companies which will do very well in this decade. Just because I am sour on large tech companies does not mean I think all technology is suspect. There are some small firms just starting today that will be giants in the next decade. Instead of hoping Cisco or JDS Uniphase will come back, I would be looking through the 100 latest companies to go public on NASDAQ. Any company that is too big I would throw out. Find a company with a built-in barrier to entry in its market, solid management and a reasonable business plan. Or conversely, look for Old Economy companies with a solid track record of growing dividends and low value ratios, and be patient. I don't pick stocks. But if I did, that is where I would be looking. As an aside, I would expect a serious continuation of this bear market rally if the Republicans can take the senate. The mere thought that we might see the double taxation of dividends go away could send the market much higher. This would be the single most bullish thing I can think of that might happen, as it would take the focus of management away from managing for expectations and into actually making money and paying it as a dividend. Sadly, even with a GOP Senate, I do not think such a measure could get through, but one could hope.