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Today's Market WrapUp 06.18.2003 Mon Tue Wed Thu Fri Puplava Archive Analyze
This I’m going to start today’s wrap with a few quotes, so you’ll know right up front where I’m heading with this essay. Idiot:
A member of a large and powerful tribe whose influence in human
affairs has always been dominant and controlling. The
good Lord set definite limits on man’s wisdom but set no limits on
his stupidity---and that’s just not fair. Tell
a man something is bad, and he’s not sure he wants to give it up.
Describe it as stupid, and he knows it’s the better part of caution
to listen. On Wall Street, they are constantly analyzing things--analyzing why the markets went up and why they went down. Which companies are a buy and on rare occasions; which companies are a sell? This analysis leads to making predictions where the market will be at the end of the month, the next quarter, or the end of the year. Which stocks should you buy now and why should you buy them? They never run out of ideas on what to buy, but have few if any reasons for selling. This advice is dispensed in general form to the investment public as news. It is then broadcast from the perch of anchors’ desks without question. It is always taken as gospel, never questioned, never analyzed. If it comes from Wall Street, it must be so. However, the prediction business is a difficult business to be in these days when trends change suddenly and without reason. Stocks go up when they should be going down. Interest rates fall when they should be going up. Commodity and bond prices are rising at the same time, another anomaly. The price of everything you need is going up while experts talk about deflation. Retail sales rise as the unemployment escalates but job losses are always better than expected. Politicians complain that we can’t afford a tax cut because the budget deficit is getting bigger. We simply don’t have the money to give back to the people who pay the taxes. We then turn around and pass a new entitlement program that will cost $400 billion. At times, it seems surreal and that the inmates of an insane asylum are running the economy and the financial markets. The Fed is hell bent on debauching the currency and don’t appear to be worried about the consequences. They are confident that monetary alchemy can solve whatever problem ailing the economy. In private, they freely admit they’re not sure what will work. The word “unconventional” is used more often when solutions are proposed. The fact that the Fed is even considering using unconventional means should alert the average investor these are not normal times and that all is not well. The economy isn’t reacting in normal fashion to policy stimulus having failed to respond to traditional measures. We now have the lowest interest rates in half a century and it is taking nearly $5 of debt to get $1 of GDP. Another way of looking at the issue is that the U.S. is now borrowing $2.5 trillion a year as the country’s debt growth goes parabolic. All of this should at least get the attention of investors; it certainly has gotten the attention of policy makers. Yet on Wall Street, our financial markets have become one giant casino where professionals and amateurs alike are encouraged to speculate. Wall Street in one sense has become the adult version of Disneyland where investors can act out their money fantasies. This is no more evident today than to view what is moving in the markets and what is analyzed and recommended. To most professionals and traders they believe the good ole’ days are back. All three major indexes are up double digits this year. Some indexes such as the SOX are up 77 percent from their October 9th lows, even though industry conditions remain anemic. The best way to describe the present euphoria is to say that the bubble is back. In reality it never fully deflated. Speculation is back in full bloom. This is reflected in what is moving the markets and the metrics used to analyze stocks. The companies that have done the best in the market this year are companies that are losing money, companies with deteriorating balance sheets and declining income statements, or companies that are constantly revising their estimates downward or having to restate their earnings. A good example is the present upgrades and recommendations for investors to overweight technology. Internet, technology, and biotech stocks have been this year’s best performers. One Internet stock, Sohu, which operates an Internet portal in China, is up 387 percent this year, and is up 2,435 percent in the last 12 months. According to Bloomberg the company had $14.4 million in sales last year and it earned $0.12 a share in Q1. It sells at 202 times earnings and has a market cap of $1.1 billion. A company with $14 million in sales and a $1 billion market cap is not an investment. It is a speculation. Fund managers don’t see it that way and all the fashionable people on Wall Street own the stock, from fund managers, pension funds, to large banks that run mutual funds. Speculation is back in fashion on the Street again, and the more speculative the investment, the greater the institutional interest. Just think of it this way-- even state pension funds such as the state of Illinois is raising money in the debt market to fund deficits and invest the proceeds in the stock market. The state hopes to make up what they lack in funding for their retirement fund by making higher returns in the stock market. Meanwhile as valuations once again reach absurd levels, there is greater interest in buying what is absurd. In fact there isn’t a day that goes by that some analyst, fund manager or Wall Street investment strategist is recommending investors put more money in the market and increase their holdings in stocks, with an emphasis in technology. There is a lot of talk about improving fundamentals and valuations improving. I’m not sure I’m living on the same planet anymore. Because everything I read from company press releases sound much different from what the analysts tell me. I get four technology letters but there is only one that I trust. The only one I read that coincides with reality and what I hear coming from company CEO’s and CFO’s is Fred Hickey’s “The High Tech Strategist.” In Fred’s own words, “It seems that investors were ripe to be fooled again. The result is one of the most disgusting speculative orgies that I’ve witnessed in my 24 years of investing experience.” Fred highlights in his newsletter the number of top company execs from the top three officers at Dell Computer, including Michael Dell, Steve Ballmer, President of Microsoft, Jeff Bezos at Amazon.com, Ken Levy of KLA Tencor, Scott Kriens of Juniper Networks, and a plethora of execs at Ebay that are selling their shares. If things are getting much better then why do companies, especially tech companies, keep firing more workers? Inventory channels are still stuffed with unsold goods, sales are anemic and declining in Asia, the one tech bright spot, and prices of most tech goods keep falling. We are back inside a bubble again, and I believe sometime soon investors are about to learn another painful lesson unless the interventionists hope they can keep the economy and the markets inflated through massive doses of credit. What worries me most is that valuations are once again at absurd levels and I hear words such as ‘stocks are cheap,’ ‘a bargain’ or that ‘fundamentals are improving.’ Worse still are the metrics used to value companies are getting silly again. If the numbers don’t look good this year, recommend a stock on the basis of next year’s earnings. If that doesn’t look good, how about 2007 earnings? Eventually if you extrapolate far enough, anything can look cheap. An example of this absurdity can be viewed in the table below. Microsoft, which has seen very little sales and earnings growth over the last three years, now looks like a value stock by comparison to other tech companies.
However, with a market cap at $278 billion, just how much further can the company grow? The company has grown earnings by only 8 and 4 percent over the last few quarters. Many of these tech heavyweights no longer are producing the same top and bottom line growth as they did during the early 90’s when their growth rates were much higher and their valuations much lower. Several of these companies have experienced negative growth in sales and earnings. However, you would never know this by following all of the spin coming from bubbleheads on cable TV or on Wall Street. A company such as Adobe has a quarter where earnings go up a penny from $0.27 last year’s quarter to $0.28 this year, and you would think miracles are occurring. In fact, instead of the penny or two a share increase analysts and anchors quote the pro forma or CRAP numbers which look far better by comparison. The numbers have improved but the improvement hasn’t been miraculous. Even then there is no mention of valuation metrics unless the analysts are talking about forward earnings in the far distant future. Yet, there is not a day that goes by that some analyst or fund manager isn’t paraded before a salivating investment crowd hoping to win back their losses, recommending investors back up the truck and load up on tech. At the same time tech stocks get over weighted, or upgraded analysts have been downgrading the energy sector. The reason is the sector has moved up and in their opinion is now overvalued. These are the same people that told us oil prices were heading back down to $20 a barrel or lower after the war with Iraq and that gas prices couldn’t hold up much longer. Oil is still selling at $30 a barrel and natural gas is selling at $5.58. Investors would be surprised to find out that a good majority of the S&P’s earnings during the first quarter came from the energy sector. If these stocks are overvalued, then I wonder what the word ‘value’ means. We’re talking about a commodity that runs industrial society and one that we cannot do without. This commodity is growing in short supply with natural gas levels at a dangerous level ahead of the next winter season. There is no way that natural gas stocks will get to the 3 trillion cubic feet by next winter. So the best hope is that winter weather is above normal. Wall Street doesn’t understand the word ‘depletion’ or decline curves very well. A comparison view of quarterly earnings is also helpful. As you can see below the real earnings miracles are coming from the energy sector, not technology. Earnings have fallen for both tech and energy in 2002. However, they have now improved substantially with higher prices despite a sputtering economy. Unlike technology, you have to replenish the gas in your car each week. You have to turn on the lights and cook from your oven. In addition, if it gets cold outside or a snowstorm envelops your area you need to have heat. You can forgo getting a new computer, buying a new cell phone or buying the latest video game player. You have few alternatives when it comes to energy.
I find it remarkable that analysts can predict a second half recovery, now the fourth year this has been predicted, and yet fail to predict a recovery in energy as well. If the economy improves as they are now forecasting, then energy use would also improve. The only difference is if things don’t improve for the economy you still need to heat your home, fill up your gas tank, turn on the lights and cook dinner. From a rational point of view which would you rather invest in a company whose earnings are growing nominally or in one that is leveraged to the price of energy regardless whether the economy grows, recovers, or declines?
The only thing that seems to be growing predictably is what investors are willing to pay to own a piece of a myth formally known as the “new era.” If energy is considered to be overvalued then I would take a low P/E stock with a solid balance sheet, a good dividend and that sells at a reasonable price then overpay for fantasy. Today's Market Speaking of fantasies back at the casino stocks sold off sharply after Kodak warned it would miss estimates. Morgan Stanley and Bear Sterns both reported lower profits due to a sharp fall in investment banking fees. Micron Technology reported wider third quarter losses indicating tech companies are still struggling with lack of pricing power, a glut in capacity and rising labor and energy costs. Initially stocks struggled then rose like rockets on optimism that things will get better. The Dow Industrials and Transports fell along with the S&P 500. The Nasdaq gapped down at the opening and at midday then went straight up like a rocket ship ending up in positive territory. Despite the plethora of bad news coming out of the technology sector investors just can’t get enough of tech stocks and are more than willing to overpay to own them. We are now approaching the end of the quarter and the half way mark for this year. This is the time that fund managers will be window dressing their portfolios. They will also be goosing the markets as the quarter closes. All talk and hype will be centered on next weeks expected interest rate cut by the alchemists at the Fed. One can only wonder as the Fed drives interest rates down to zero like Japan what the 13th rate cut will do that the other 12 failed to achieve. Perhaps they will manage to create and inflate another bubble. We already have bubbles in real estate, mortgages, bonds, and stocks. Perhaps the next bubble is going to be in “things.” It is remarkable that gold and precious metals stocks have held up this well during a period when paper assets are inflating. It could be the inflating part that is holding up the metals. At the end of the day tech stocks ended up on the positive side while industrial and financial stocks fell. In addition to warnings coming from the industrial and financial sector, Clorox warned its earnings would come in at the lower end of forecasts. The New York Times also issued a warning that its earnings would be at the lower end of estimates. Meanwhile tech and semiconductor stocks took off after a Lehman analyst said that PMC Sierra, Vitesse Semiconductor, and Applied Micro Circuits would receive more orders because inventory levels at phone-equipment companies have dropped to the lowest levels in three years. The three companies have been experiencing negative earnings. However, they currently sell at 10- times book value and 10-11 times sales. PMC Sierra has 2 buys, 10 holds, and 4 sells. Vitesse has 1 buy, 8 holds, and 1 sell. One analyst has a buy on Applied Micro, eleven have a hold and 5 have issued a sell. Shares of all three rose today as much as 10 percent based on the positive comments coming from Lehman. The positive comments along with Oracle raising its bid for PeopleSoft helped the Nasdaq go from negative to positive territory. Volume hit 1.46 billion on the NYSE and 2.08 on the Nasdaq. Market breath was negative by 20-13 on the Big Board and even on the Nasdaq. The VIX fell .17 to 21.60 and the VXN edged lower by .46 to 33.15. Copyright
© 2003 Jim Puplava Graphic Source: www.stockcharts.com
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