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Strategies & Market Trends : Waiting for the big Kahuna -- Ignore unavailable to you. Want to Upgrade?

To: William H Huebl who wrote (15146)	3/19/1998 11:26:00 AM
From: Don Westermeyer	Read Replies (2) \| Respond to of 94695

Bubble Theory 101 - From Briefing: briefing.com Wall Street has given up on valuation: rationalizing it, that is. There is no longer any pretense. Now the argument is that stocks are going higher because someone will pay more tomorrow. A Quick Look Back Here are some quaint concepts about valuation from years gone by: Dividend discount models: based in financial theory, these models value assets (such as stocks) based on the present value of future returns (such as dividends). These models were frequently cited in the 1980's because the showed stocks undervalued. Price/earnings (P/E) ratio: Once commonly used to measure a stocks current price compared to its past four quarter earnings, the P/E lost favor once levels went well above historical norms, inconveniently suggesting stocks might be overpriced. Future P/E and relative P/E:Future P/E, using next year's earnings instead of prior year's, helped make P/E's look more reasonable and became increasingly common in the early 1990's. However, when that too became inconvenient in recent years, relative P/E's became prevalent. This measures the P/E of a stock relative to other stocks. Of course, by this method, 50% of the market can always be described as undervalued. None of these valuation measures are talked about much today, if at all. In fact, to raise them is to risk ridicule. After all, stocks have gone up in recent years, so valuation was irrelevant. It therefore is assumed to be irrelevant now as well, and may indeed prove to be so. Higher Prices Tomorrow What is the argument for buying stocks today? Listen to the pundits and the brokerage firms and the argument is consistent if simple: stocks are going up further because they have gone up in the past, and because the money will keep flowing in. This is literally an argument that there will be another buyer later, so don't worry today. Broken down, it is no more than an argument that the bubble will keep growing. Fundamentals Ignored as Earnings Slow It is only recently that the argument for rising stock prices has given way entirely to the bubble rationale. In fact, through last summer, the mantra was that technology would lead to increased productivity and lower inflation with persistent 15% earnings growth. It was a compelling and essentially correct argument and is still an underlying long-term assumption. Unfortunately, earnings are not cooperating now. Earnings growth has slowed dramatically in the first quarter, and may be approaching zero. So, the argument about continual earnings growth has been temporarily shelved. New Way of Looking at Issues The market has thus avoided talking about valuation. The fundamentals just aren't cooperating well enough with the rally that understandably has Wall Street palpably giddy. In its place we have heard some interesting arguments lately. These were all meant to be serious, as far as we know. Lower earnings estimates are good news. They make it easier for companies to beat estimates when they report. Stocks go up when brokers raise price targets. Higher stock prices, even with lower earnings estimates, means that target prices have to be raised, which leads to buying and thus higher prices. See Coke. Bad news is good, because it provides an opportunity to get in right away. If a company warns that it won't hit its earnings numbers, wait until after the open, then buy. See Bay Networks. This is earnings warnings season, so bad news is expected. Ignore it. The bad news is supposedly in the market, even though stock prices have gone up, and the earnings slowdown is far worse than any other in recent years. The only thing that can stop this market is a nuclear holocaust. (Hey, if we can just talk about it a little, maybe that could become "expected" as well, and could provide another buying opportunity.) Just an Observation Briefing is not making any forecast, just an an observation. The dramatic slowdown in earnings, at a time when stock prices have continued sharply higher, has led to almost a state of denial on Wall Street. Earnings just don't matter. And as long as the market goes up, that is true. In place of the fundamentals, discussion has turned to daily issues such as which stocks are splitting and which have been upgraded by a major broker. Behind it all lies the assumption that there will continue to be more demand for stocks than supply (sellers), so the market will keep going up. It may be pure bubble theory, but the market is learning to love it. So are we.