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MORNING COMMENTS WEEK OF 12/06/99-12/10/99

 

12/10/99

NO COMMENTARY PUBLISHED

12/09/99

NO COMMENTARY PUBLISHED

12/08/99

The march of the gullible continues to gather momentum as the soldiers rapidly fall into line behind the pied pipers of the boiler room scheme to end all boiler room schemes, educated investment decisions become a thing of the past as the primal urge of greed takes over and turns the investment landscape into a sea of hoodwinked seekers of the fast path to instant riches--riches that in the end will only be obtained by the New Era's new breed of boiler room operators and the companies, long on promise but still far short of reaching that promise, that they shamelessly promote.

In an era when access to vast new stores of information should provide enlightenment and an increase in independent thought, we are instead seeing the opposite as many long term investors, suffering from information overload and lulled into complacency by the promise of easy street, forsake independent research and instead succumb to the lure of paid shrills shameless promotional research reports--reports based on dreams that may never be attained, reports that speak of boundless potential but fail to question the odds of that potential being reached.

In a market where hope of a perfect set of future circumstances has supplanted the reality of actual corporate performance as a basis for determining equity valuation levels, investors would be well advised to step out of the din created by an analyst community that long ago was pressured to erase the word sell from its vocabulary. Rather than betting their future prosperity solely on the manufactured hopes provided by a community seeking to bolster the investment banking side of its business, investors should take the time to harness the vast store of information that is now at their disposal and to use that new found knowledge as a tool to independently quantify the actual potential of the endless barrage of dreams that they are fed.

Although the daily diet of force fed illusions of infinite growth have drawn many in and created companies whose multibillion dollar market caps teeter precariously on the hopes of a perfect course of unimpeded future corporate development, it should be remembered that while the potential for many companies is great, it is not infinite, and no company operates in a vacuum free from the dangers of unseen technological change and obsolescence, the emergence of new competitors, and other corporate missteps that may arise and render current projections unattainable.

While growth stocks historically have been accorded a higher multiple, it is important to remember that this multiple is based on a discounting of the quantifiable projection of the future size of the company's business and profit potential.  Thus (to leave out profits for the moment and instead focus on the market's current obsession with revenue growth), historically, a company with $1 billion in current revenues with a projected 5-year growth rate of 20% a year would have been accorded the same market cap as a company with $2 billion in revenues growing at 5% a year.

In the current market environment, the relationship between the achievable future size of the company's business  and its current valuation have largely been lost. Companies with the potential to grow into $5 billion a year businesses are now accorded market caps that far exceed those of companies with $50 billion in annual revenues.

A case in point is today's newest member of the S&P 500, Yahoo. Before yesterday's 67 point surge, the company (with $465 million in revenues, $58 million in after tax income) had a higher market cap than either General Motors ($176 billion in revenues, $6.6 billion in after tax income) or Ford ($156 billion in revenues, $6.5 billion in after tax income). Looking at the relationship between the valuation accorded to Yahoo and the valuation given to the two automakers, one of three conclusions can be drawn: a. the market believes Yahoo's revenues and earnings will one day exceed General Motors current numbers; b. the two automakers are severely undervalued; or c. Yahoo is severely overvalued based on the realistically achievable future size of its business.

After watching Yahoo's market cap surpass those accorded such heavyweights as Time Warner ($23 billion in revenues), Motorola ($30 billion in revenues), United Parcel Service ($26 billion in revenues), Bell South ($24 billion in revenues), and Bank of America ($37 billion in revenues) during yesterday's romp, one can only come to the conclusion that the correct answer is (c) Yahoo is severely overvalued based on its future potential.

For those investors who profess "to be in it for the long term" and have bought in at current valuation levels based on the pied piper tune played by the 15 analysts who rate the stock a strong buy, we advise getting a large box of Kleenex because at current valuation levels Yahoo, despite its potential, is unlikely to bring anything but tears to anyone who is in it for longer than the short term...something that can be said for many of the stocks in today's overheated tech and Internet sectors.

12/07/99

NO COMMENTARY PUBLISHED

12/06/99

The subject of scorn earlier in the week, the speaker with a hawkish fork to the tongue should now be the subject of praise, for in the end it was he who saved the day--it was he who made possible the jubilant celebration of euphoric relief that sent stock and bond traders scurrying to the nearest phone to place buy orders on Friday.

The man who deserves the lion's share of the credit for Friday's rally is Federal Reserve Governor Laurence H. Meyer. His hawkish speech last Tuesday caused the market's myopic visions and fears to focus squarely on the unemployment rate to the exclusion of all else, thereby setting the stage for a powerful relief rally when the number came in unchanged.

Despite investors' relief that the unemployment rate didn't fall further, and despite their belief that low current inflation readings equate to no further interest rate hikes by the Fed, Friday's release of November employment data will do little to sway the Fed either way.  At best, the report was neutral pending further data, at worst, it tilted the odds ever so slightly towards the necessity of further Fed action down the road.

The unemployment rate remained steady at 4.1% in November as Nonfarm Payrolls increased 234,000 and average hourly earnings rose just 0.1%.  The pool of available labor increased slightly, but not enough to ease the tightest labor market conditions in nearly 30 years.

The increase of 234,000 nonfarm jobs, although down from October's revised 263,000 gain, still indicates a strong demand for new workers, and the figure would have been even stronger if tight labor market conditions weren't holding down the growth in nonfarm payroll numbers as employers struggle to find qualified applicants.  Combine the gains in nonfarm payrolls with an increase in the average workweek and other recent demand orientated economic data, and a picture emerges of an economy about to enjoy another quarter of 5% plus growth.

While the strong job gains, combined with a lower than expected increase in average hourly earnings caused many to proclaim inflation dead on Friday, we wouldn't be so quick to jump on the "boundless prosperity, no inflation, the Fed menace is dead" bandwagon.

Many of the pundits who were rejoicing the rebirth of the Goldilockian era on Friday are also the same pundits who are oft heard to proclaim, "technology and the Internet have changed the rules, it's a New Era".  In many ways they're right, and the rules have changed: from Silicon Alley to Silicon Valley wages are often no longer the primary draw in luring potential employees --instead promises of hefty stock option packages have become the primary lure and constitute a large part of a worker's total compensation.

While the effect of stock options is not adequately reflected in the average hourly earnings figures, its effect is fully felt by the economy as the wealth effect fuels economic growth.  Wage growth may have been subdued in November, but the sharp rise in the value of stock options during the month as technology and Internet stocks surged to almost daily new record highs is sure to be felt in the form of rising consumer confidence and rising consumer spending in coming months--hardly the sort of activity that signals the economy is about to slow to a more sustainable pace or that labor market tightness is about to ease, and hardly the sort of activity that suggests the threat of further Fed moves has passed.

Going forward, an economy growing at an unsustainable pace is likely to be the least of the market's problems. Complacency and euphoria remain the stock market's biggest problems, and leave it extremely vulnerable to any unexpected events.

The degree of complacency among the traditional 'buy and hold for the long term' investor is particularly troubling.  The most recent investor sentiment poll of its members by the American Association of Individual Investors shows 62% are bullish and only 13% bearish--readings that normally signal a top is approaching.

Monday's profit taking in the wake of Friday's sharp runup was to be expected, and the market will likely pick up where it left off and continue higher for a few more days, or weeks, or perhaps even months, before this blowoff top reaches the final peak, but with each step higher, the danger grows, and the distance the pendulum of market sentiment is likely to over swing to the downside when the final top comes increases.

Friday's employment report may have been better than expected, and all three major averages may be trading near record levels, but we wouldn't lose sight of the risks posed by the other side of the coin: consumer-fed economic growth remains at levels that will likely force the Fed's hand in the coming months, and despite new records by the S&P and NASDAQ on Friday, more stocks on the NASDAQ and NYSE lost ground last week than gained.

Getting swept up in the euphoria of the moment is always the most tempting near the end of a move as the last holdouts finally succumb, but we would resist its pull and keep one eye out for possible exits, and remember that historically parabolic rises are followed by even steeper falls--the question of how far the market will overshoot to the downside depends on the resolve of  those investors who are 'in it for the long term'.  We have a feeling that resolve may be a little weaker than many expect if history holds true to course.

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Last modified: April 02, 2001

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