THE HIGH TECH ARENA
MARKET UPDATE
Greetings and felicitations from the Hamptons.
I have been on vacation for the last two weeks, but in light of recent
market events, here are some thoughts for surviving this correction.
Having lived through the crash of 1987 (and being 180% invested), let
me
first assert that today's action was only vaguely reminiscent of 1987.
Certainly, there were some signs of capitulation, especially the new
lows of
almost 1500 on the Nasdaq, over 4000 losers on the Nasdaq, and the
billion
share volume. The put/call ratio, the VIX (volatility index) also
provide some
evidence of a short term bottom here. The TRIN, however, was not that
negative today. More importantly, the sentiment that I have seen among
individual investors does not indicate the ubiquitous panic that we saw
in
1987. The indiscriminate selling of market high tech leaders such as
MSFT,
DELL, and CSCO is a sign that we are attempting to put in a significant
intermediate term bottom. The Internet stocks, having led the way up,
are now
leading the way back down. These are all signs of a return to
rationality in
the markets, where valuation levels regain some semblance of historical
norms.
Although I do believe the selling in MSFT and CSCO was overdone
today, and I
do believe we will get a sharp reflex rally today or Wednesday, the
case can
be made that these stocks have further downside risk short term. If
conditions in Asia worsen, and the Russian debacle wreaks havoc in Latin
American and other developing economies, and Japan does not develop a
plan for
implementing meaningful economic reforms, we could be in for a
protracted
correction. Under this scenario, it would be well within the realm of
reality
for MSFT and CSCO to trade at multiples more in line with their growth
rates.
Give these stocks a p/e ratio of 40 and 30 times earnings respectively
(based
on the current fiscal year consensus estimates), and you have a price
target
of about 85 for MSFT and 65 for CSCO. While I do not believe these
downside
targets will be sustained for any length of time, it is prudent to
consider a
possible worst case scenario. However, I have been saying for quite
some time
that the yield on the long bond will go to 4.75% within the next 12-18
months.
Under this scenario, investors may still be willing to pay premium
multiples
for consistent double digit earnings growth, and MSFT and CSCO may still
justify prices which equate to 50 or 60 times earnings.
Long term investors should absolutely not be scared out of what are
arguably
the two highest quality technology stocks in the world. This is the
time when
the concept of dollar cost averaging should be utilized to establish new
positions in MSFT and CSCO, or add to existing positions. In this
market
environment, the investor who is able to separate the emotion from the
intellect will win in the long run. For example, what is happening now
will
not hurt MSFT's lofty 91% gross margins, will not impact new product
introductions, and will hurt only slightly new revenue streams.
Witness the
recent news from Japan on Windows 98 sales being dramatically ahead of
plan,
and also Windows 98 being launched in China. Regarding CSCO, bear in
mind
that Asia accounts for only 7% of their business, and they are not even
factoring Asia into their growth targets for the next two years. CSCO
investors must keep in focus that only 3% of the world has Internet
access,
developing nations must embrace the Internet to become competitive, and
CSCO
is building the backbone of the Internet.
On a short term basis, I expect that selling into strength will be a
winning
strategy over the next few months. Too much technical damage has been
sustained by this market to simply put in a V shaped bottom. Therefore,
instead of continuing to short out of the money puts on MSFT and CSCO
for the
next few months, I will write covered calls against the 01 Leaps calls
that I
am long to generate trading income. Fortunately, since I decided to
take a
vacation last week, I did not short the CSCO Sept 90 puts as I
indicated I
might in my last letter.
Those who have missed out on the TXN trade (i.e., shorting 00 45
puts), the
market has provided another opportunity to do so. The rationale for
shorting
puts on this stock is that it has already been in a bear market, and is
getting close to it's 52 week low. The bear market in the SOX has also
dragged down TXN, somewhat indiscriminately. Their DSP business remains
strong, with 20% growth still expected this year, and 30% next year.
As many
of you recall, I had shorted the 00 45 puts at 5 7/8, and would love to
own
this stock at around 39, which would be my net cost if the stock is put
to me.
DISCLAIMER: THIS E-MAIL DOES NOT CONSTITUTE AN OFFER TO BUY OR SELL
SECURITIES, AND IS INTENDED FOR INFORMATIONAL PURPOSES ONLY.
Joe Arena
The High Tech Arena
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