Where is sector going? Read this. I dont know or want to bother highlighting. So find it where it should be.
FRIDAY, SEPTEMBER 18, 1998
While the media, as well as investors, are keenly focused on daily stock market fluctuations, overseas financial and economic
turmoil and President Clinton's evolving predicament, less fascinating but certainly very important developments are now
transpiring within the US economy. Today we had a disappointing report on housing starts which fell 5.5% during August, the
largest decline in two years. We see this as one of the first signs that problems in the financial markets are now impacting the
economy. Importantly, multifamily starts fell almost 10%. This is not surprising, and we expect the situation to get much worse,
as REIT's and other apartment developers have been cut off by the marketplace from new borrowings. Also, today Toll
Brothers, a major luxury home builder, announced that the company would not meet Wall Street earnings estimates. This came
as quite a surprise to the Street who erroneously presume that low interest rates ensure a never ending real estate boom. While
a real estate boom has been a major factor in driving US economic growth, we see the initial signs of boom turning to bust.
Earlier this week the University of Michigan released its preliminary report on September consumer sentiment. This report also
signals a downturn as the composite confidence number dropped to 100.4 from last month's 104.4. Most noteworthy, the
largest decline occurred to consumer expectations for the future which slid to 93.2 from 98.3. This is certainly a harbinger of
less buying, especially for major purchases such as automobiles and homes. This is consistent with a disappointing retail sales
report earlier in the week which showed a decline in automobile sales, building materials and hardware. A separate retail
report showed an overall decline in retail sales. Other signs of declining economic prospects are coming from a plethora of
companies reporting that earnings will disappoint, including Union Carbide, Gillette, and Caterpillar. Companies, particularly
Wall Street firms and international banks, are also announcing large job cuts.
With considerable volatility, much likely related to triple-witching option expiration, the Dow and S&P500 finished the week
with 1% gains. Much stronger gains were reported by previously lagging groups with the transportation stocks surging 5% and
the small cap Russell 2000 gaining 3%. Financial stocks, despite overwhelming negative fundamentals, also rallied strongly with
both the S&P Bank index and the Bloomberg Wall Street index gaining 2%. With considerable investor nervousness related to
upcoming earnings reports, the Morgan Stanley Consumer index performed poorly this week with a gain of less than 1%.
Considerable earnings uncertainly also appears to be impacting technology stocks. For the week, the tech stocks were notable
for their lackluster performance with the NASDAQ 100 and Morgan Stanley High Tech index mustering only 1% gains.
Semiconductor stocks performed even worse with the index unchanged on the week. Certainly, investors have plenty of
reason to fear upcoming earnings announcements. Recently, earnings warnings have come from an area that the bulls thought
was isolated from trouble - the telecommunications industry. With recent warnings from the likes of Ciena and Alcatel, it now
looks like bullish expectations for the telecommunications industry to drive growth for companies throughout the technology
industry was much too optimistic. Importantly, with the junk bond market currently essentially closed to new borrowing for
much of the industry, we expect that we are now seeing just the earliest signs of what could be a dramatic industry downturn.
In particular, this is an industry that we believe will suffer greatly due to quite negative developments in the US credit markets.
IS THE CURRENT STOCK MARKET "A BUBBLE"?
"Bubble" - a light hollow ball, Webster's II. The stock market is a "bubble" looking for a pin. The purchase of a securities at
one price may be an investment, at a higher price - speculation, at an even higher price - irrational exuberance, and today,
2500 points above "irrational exuberance", the greater fool theory.
Everyone is investing in the market. People buy at high prices and expect to sell at ever-higher prices. The overall stock market
is selling at the highest valuation in more than seventy years. People have forgotten that in order to "buy low, and sell high", you
have to sell.
It is extremely rare for a Federal Reserve Chairman to warn investors about the stock market. This has happened only twice
before in this century (1929, 1965), and in both cases, a severe bear market followed that required more than twenty years to
breakeven after inflation. Alan Greenspan chooses his words very carefully. Yet Greenspan referred to the stock market as "a
bubble" in a prepared speech when the Dow was about 6000.
Only in a bubble can a stock like At Home Corporation be worth $2 billion on its first day of trading when it posted revenue
of only $2 million and lost $23 million for its previous six months. Slow-growing companies like Procter & Gamble and
Coca-Cola are posting sales growth of 4% and 2%, respectively, yet are selling at 31 and 41 times earnings. Normally, the
P/E's of stocks sell closer to their growth rates. These companies have been posting earnings growth slightly faster than sales,
but not by much, and this never lasts forever. In the 1960's, people justified paying-up for great companies that would
continue to grow, but look at their market returns from 1973-74 - (Coca-Cola -70%, Walt Disney Co -85%, PepsiCo
-67%).
So why can't I wait until the end gets closer? "Times are too good now for the bubble to burst yet", you say. I only wish it was
this easy. People always ignore history. They fail to realize that markets always get the most overvalued when times appear to
be wonderful. The view is always clearest at the top. But it "feels so good" when the economy is strong, and everyone is
making money "hand over fist" that people ignore the perils of a ridiculously overvalued market. Stock market moves nearly
always precede economic events, and therefore people rarely predict the event which might cause a market decline. But in a
bubble, they always think they can. When times are the best, all you have left is risk.
Stock markets never go up forever. It's not as easy as Wall Street would like you to believe. It isn't typical for money to be
given away on Wall Street, but with the Dow Jones average increasing at a 19% rate since 1982, it seems like it. Consider the
recent warnings of Greenspan, Buffett and Templeton. Think more about preservation of capital and less about greed.
Expressing caution today is like being against motherhood and apple pie. History does repeat itself, so to protect yourself and
your family's future, don't invest in a "bubble".
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