Here's an intriguing article written by a bear fund manager. Although obviously biased, he makes some good points on the current sector rotation out of techs:
Wednesday, March 3, 1999
Bond yields continue to march higher, closing at 5.7% today while the stock market looked poised for a critical break below the trading range that has held now for the past two months. The bulls, however, had other things in mind, coming in and buying aggressively in the final hour, cutting the Dow's loss to 22 points. The NASDAQ Composite rallied 1 ½% during the final hour to squeak out a gain for the day. For the week so far, the Dow has lost 30 points and the S&P has shed almost 1%, in what continues to be an extraordinary market environment. The technology sector remains under pressure as investors now begin to worry that industry weakness goes beyond just slowing PC sales. With 3Coms earnings disappointment, one may now suspect that the networking and communications companies are vulnerable as well. So far this week, the NASDAQ 100 and semiconductor stocks have lost about 1% and the Morgan Stanley High Tech index has declined 3%. The Internet stocks continue to rise with The Street.com index gaining 2% this week. Most other indices have been relatively quiet with the Morgan Stanley Cyclical and Morgan Stanley Consumer index both posting small declines, and the Transports and Utilities showing gains of about 1%. The financial stocks, although looking vulnerable, continue to perform surprisingly well with the S&P Bank index rising 1% and the Bloomberg Wall Street index with only small decline.
We do not agree with the bulls on many points but we do concur wholeheartedly that momentous leadership from the technology and financial sectors has for years been the real engine powering this historic bull market. Coming out of the brief bear market back in late 1990, the NASDAQ 100 traded at about 170. Just last Wednesday the NDX traded at 2055. Back in October of 1990, the New York Stock Exchange (NYSE) Financial Index traded at about 100, while mid-day yesterday traded above 535. Obviously, both groups have had tremendous gains during this long bull market, and both groups have led the market during the past few months. Indeed, the NASDAQ 100 traded as low as 1063 on October 8th but proceeded to double in price in less than four months. The NYSE Financials traded to 379 on October 8th and gained almost 40% in three months. With this strong recovery in both sectors, the bulls once again confidently trumpeted the mantra "lower interest rates and the technology revolution forever", remaining steadfast in their view of the sound footing for the continuation of the bull market. Clearly, these two sectors today, are the pillars supporting the bull case.
Well, not only have interest rates moved higher, the critical bull market technology pillar is cracking. Despite what the bulls would like us to believe, technology is traditionally a keenly competitive and cyclical industry. It has certainly become much more competitive as easy access to capital has led to a huge proliferation of new companies and products. In hindsight, historians will see this as a period of massive over spending and malinvestment throughout the technology industry, not dissimilar to the excesses that have left Asia with massive overcapacity in semiconductors and other electronic components, as well as ravaged financial systems and economies. Alarmingly, the global nature of this massive overinvestment in technology components is too reminiscent of the huge expenditures during the 1920's that ended tragically with massive worldwide overcapacity and collapsing prices for automobile components and the resulting financial and economic debacle that developed into the Great Depression.
And in fact, signs of approaching tech trouble have been around for some time now both globally and here at home. Importantly, the fundamentals of only the strongest companies have been holding up well from intense competitive pressures and massive global overcapacity. The vast majority of companies, however, have seen earnings suffer mightily from collapsing prices for most technology components. And while such global deflationary conditions have been of great benefit to American PC companies that are basically assemblers of components, allowing them to lower prices which has stimulated unit sales growth, this has only prolonged the boom, leaving today a much more vulnerable industry. Now with business prospects for leadership companies such as Intel, Compaq and Dell faltering, competitive pressures have made it to the top of the food chain, bringing future profitability and current extraordinary valuations into question. Investors are now awakening to the travails in the PC and semiconductor industries where falling prices and slowing demand will wreck havoc with future earnings. Clearly, euphoric investors have pushed valuations to ridiculous levels that are in no way supported by earnings prospects and, with this, now comes the painful bust after quite a speculative melee.
With this in mind, the key question today is whether or not the bull market can survive a major technology selloff. Clearly, for the bull market to have much chance of continuing in the face of a faltering tech sector, the financial stocks must perform well. And, of late, this has indeed been the case as the strongest S&P groups during the past week include the Wall Street brokers, money center banks and insurance companies. Certainly recognizing the key importance of the financial sector in the midst of a vulnerable marketplace, Wall Street has recently been quite vocal in its support for financial companies and the financial services industry as a whole. It is our view, however, that recent Wall Street's bullish spin is more self-seeking propaganda than objective analysis. Only Wall Street analysis could come to conclude that higher interest rates and general turbulence in the credit markets are good for banks, Wall Street firms and other financial companies.
In fact, we must state that much of the recent Wall Street analysis regarding the financial sector simply lacks credibility. In the face of a crushing credit market sell-off with sharply higher interest rates and a growing financial and economic debacle developing in Brazil and Latin America, bullish analysts have gone so far as to claim that this is a very good environment for the international money center banks and Wall Street firms. We just don't see how being highly leveraged holders of both domestic and international securities can lead to anything but trouble today. Nonetheless, one bullish analyst, appearing on CNBC, went so far as to claim that bank earnings depend not on the level of interest rates but only on "spreads". And because spreads have narrowed, this is "constructive" for bank earnings. It's funny, the bull story so propagated for years was how these companies would prosper with lower rates. Now with rates moving sharply higher, the bull story has conveniently changed. This same analyst stated that that the current environment was also good news for investment banking and trading revenues. Well, we can see many ramifications for the developing financial crisis but none of them are constructive for money center banks or the Wall Street firms. All the same, for the short-term, the performance of the financial stocks should be watched very closely.
Actually, we suspect that mutual fund managers are today buying the financials not on the basis of future prospects, but instead in a diligent effort to support the faltering bull market. With the market trading in a tight trading range for two months now, there is certainly much to lose if this range is broken.
Interestingly, today's extraordinary market environment seems to provide two very fascinating stories. First is the ending of the wild speculative melee that drove technology prices to astonishing excesses despite deteriorating industry fundamentals. Amazingly, euphoric, and we will add irrational, investors became overwhelmingly bullish and fully invested right as the PC industry and related businesses began to turn sour. Today this bubble is in the process of bursting. This will come as quite a shock for the millions of on-line traders and thousands of mutual fund managers who invested in these stocks, not because of fundamentals but because of momentum and the herd mentality to speculate in the technology theme. Too many own these stocks without any understanding of the underlying businesses and we suspect they will dump them when the pain of losses becomes too great. Certainly, this has all the makings for a debacle.
Meanwhile, a second equally fascinating but much subtler story evolves. As Wall Street scurries away from technology, it has become quite interesting to watch which stocks Wall Street now tries to love. Today, Wall Street is really trying to love the banks, insurance companies, retailers, HMO's, gaming stocks, restaurants, telecommunications and, even today, the oil services sector. We suspect these groups could be a tough sell going forward. We just don't see any of these groups providing investors good value or much in the way of compelling earnings prospects. Instead, they seem to win by default. In our eyes, this looks much more like a desperate attempt to hold the market averages together than anything resembling sound, objective research; more of a money game than anything else. A good analogy is that today Wall Street bulls are like a used car salesman who after realizing that a prospect can not afford the high priced model, proceeds to work desperately to sell any vehicle on the lot just to garner a commission. Today, with the foundations of the bull market beginning to crumble, the bulls are working overtime peddling whatever they can sell. Here we see very fragile market underpinnings and state unequivocally, BUYER BEWARE!
|
