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Strategies & Market Trends : Roger's 1998 Short Picks -- Ignore unavailable to you. Want to Upgrade?

To: Oeconomicus who wrote (9330)	5/29/1998 12:38:00 AM
From: Pancho Villa	Read Replies (1) \| Respond to of 18691

it will be very intersting to see Q2 earnings. My prediction is that we will see a deterioration of earnings vs. previous quarter and year ago for each of the remaining three quarters of 98. IMO the Asian crisis is finally hitting the world economy; transnationals with lower revenues/earnings due to poor results in Asia will cut down spending in an effort to keep earnings from falling dramatically. This means Mr. Dell will have to wait to sell new computers to corporation X as the boss says "your low speed pentium/486 will do for another year". This will cause a domino effect in wich company after company reduces spending, in turn reducing revenues for the corporations from which they would have bought. These corporations in turns reduce spending to protect their earnings. the bottom line will be a significant economic slowdown. We can kiss good buy to 10%+ earnings growth. IMO we will enter a period of negative economic/earnings growth. The Fed, in may opinion will/should do nothing after all Mr. greenspan is supposed to be worried about the inflated equity market. In an deflationary environment the current rates will feel sky high, so he may have the opportunity the pierce the bubble by doing nothing. Pancho FWIW many finance textbooks try to explain how a relatively small change in the perceived rate of earnings growth could explain the significant correction of 87. The argument goes af follows: PE=1/(r-g) in which r is the expected return from stocks and g the expected earnigns growth. r can be estimated as the current t bill rate plus appx. 8.5%, the historical premium that stocks have returned above t bills (it can bbe argued that investors in this new era are demanding less of a premium but we will stick to historic norms) so r=5 + 8.5 = 13.5%. We see that for g=10% PE=1/(.135 - .10)= 28.6, which is very close to the current PE of the S&P 500. Sot the market seems to be pricing 10% earings growth. Let's try now g=9%, which represents only a 10% reduction in expected earnings growth. we get PE=1/(.135-.09) = 22.2 This implies a correction of 22.2/28.6 = .78 or a 22% decline! Do the exercise for g=8% which is pretty reasonable and tell me what you get. Pancho This is a simple model that assumes earnings grow at g for ever and is not supposed to track reality perfectly but it helps the thought process.