crosspost,from another AMAT bull, re. market conditions:
Subject: Watson Pharmaceuticals
To: +FNS (69 )
From: +Jacob Snyder Sunday, Mar 22 1998 6:17PM EST
Reply # of 70
to FNS, Dan'l: thanks for the compliments, but I was wrong.
The S&P 500 has broken above the trading range I thought it was in, and Watson Pharmaceuticals was not making a double top (just a pause to catch its breath before resuming its upward momentum. The stock is now 20% above where I got out. Still, I can't complain, since the money went into Boston Scientific, which has gone from 45 to 70 in the last 4 months.
I'm noticing a consistent pattern in my investing: I do a good job picking quality companies (I have a short list of companies that are the best in the world at what they do, have a track record of growing EPS at 20% a year, have pristine balance sheets, and aren't doing anything on my long list of "stupid things companies do"). I do a fairly good job of buying from that list when the stocks are out of favor and undervalued. Sometimes I time it exactly right, but sometimes I buy too early, and the stock makes another stair-step down after I buy. I need to have the courage, when that happens, to buy more and hold till the industry rotates back into favor.
But, in the last two years, I've done a generally poor job of picking when to get out. Consistently, I sell when I calculate that the stock is at the upper end of fair value, based on a recent run-up or where it is in its historical PE range. I convince myself, based on short-term TA, that momentum has been broken. I sell the stock, and then it goes up another 30-100%. The momentum players who I sell to make just as much as I did.
However, I don't think I'm going to change my methods. I think the reason I'm getting out too soon, consistently, is that there are many investors who are willing to pay more for stocks than they are really worth. At some point this euphoria will end, and the S&P 500 will tumble to a PE of 18, (where it belongs, even without a recession). 20 minus the inflation rate equals fair value PE. Current valuations are based on an absence of inflation, and an expectation of double-digit EPS growth. The chance of both those assumptions holding true through the next two years (1998 and 1999), are zero, I believe. Either earnings growth will decline to 0-5% (and stay there for several years), or inflation will double (from 2 to at least 4%).
My prognosis: GNP will grow, workers will continue to be hired, the big U.S. multinationals will continue to grab global market share in the post-Cold-War enlarged playground for Capitalism, sales will be robust. But..... margins will get squeezed, low-cost producers will survive with lower earnings, and high-cost producers will die. The top one to five companies in every industry will get bigger, at everyone else's expense. Basically, what's happened recently in the PC industry is going to spread to the entire economy. Greenspan has stated about 50 times in the last year that when he sees inflation, he will raise interest rates to whatever extent necessary to stop it. The Asian thing has delayed, for a year or so, the day he does it. Real wages have been climbing for a couple of years, and will force earnings down or prices up. The math is simple and inescapable.
Based on what happened in 1987, and October 1997, it's very possible the correction could take place with no warning, on a single day. Until that day, momentum investors will do better than value investors. Then, the momentum investors who I am selling to will have a very bad day. A decline in the S&P 500 PE to 18, implies about a 350 point decline, to about 750. In the last 4 months my portfolio has gone from 35% margin/no cash to no margin/5% cash. I'm looking for overvalued internet/drug/biotech/semiconductor equipment stocks to short. And I'm thinking of selling my Boston Scientific.
The storm is coming. Those who are running before the wind with all canvas aloft will be demasted when the squall hits. Those who are setting the sea-anchor, going to port, or at least taking in sail, will win the race. Happy sailing.
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