Times like these make me sigh, hold my head in my hands, and groan, "How is it possible that, in less than three months, investors seem to have forgotten all of the painful lessons of the previous three years?"
Rampant speculation has returned in the stock and especially the bond markets, apparently driven by the belief that our economy is poised for a massive recovery and that American corporations and consumers are fabulous credits. I don't believe it. At best, I think we're going to continue to muddle along in a three-steps-forward, two-steps-back fashion -- and if I'm right, there will be very painful consequences for many stock and bond investors because prices already reflect a rosy scenario.
Since the most recent market bottom on March 11th, the Nasdaq has soared 29.5% and the S&P 500 24.4% -- leaving the S&P trading at more than 30x trailing earnings, double the S&P's long-term historical average P/E ratio of 15.5.
As for the Nasdaq, valuations are even more ridiculous. There are the usual suspets -- Cisco (Nasdaq: CSCO ) , Microsoft (Nasdaq: MSFT ) , Dell (Nasdaq: DELL ) , Oracle (Nasdaq: ORCL ) , eBay (Nasdaq: EBAY ) , and then some. Take a look at the P/E ratios of 15 popular large-cap tech stocks (I'm giving the companies every benefit of the doubt by using 2003 consensus analyst-estimated earnings, which are surely too high; also, these earnings do not include the cost of stock options, which will likely have to be expensed in the future):
Stock P/EAltera 53Applied Materials 130Cisco 28Dell 32eBay 69Intel 36KLA-Tencor 57Linear Technology 44Maxim Integ Products 37Microsoft 23Oracle 30Qualcomm 25Texas Instruments 52 Xilinx 46Yahoo 84Average 50
Does the outlook for the technology sector warrant these nose-bleed valuations? Not according to Fred Hickey, author of The High-Tech Strategist newsletter, which has been uncannily accurate for years (incidentally, it's the only newsletter I subscribe to -- with the exception of The Motley Fool Select, to which I have contributed). A month ago he wrote: "The fundamentals stink. While the bullmeisters spin tales of another second half rebound that won't occur, the current reality is quite different, with demand sinking while supplies are mushrooming. It's hard to believe, but the gap between perception and reality is worse today than during any one of the failed sucker's rallies of the past three years."
Due mainly to SARS, Hickey argued that "the bigger economic disaster for the tech industry will come from the collapse in demand for tech products in Asia in Q2, the world's fastest-growing market."
Top executives apparently agree with Hickey, as they're selling like mad. For example, Microsoft's CEO, Steve Ballmer, just sold $1.44 billion of stock, nearly 10% of his total holdings and his first stock sales since 1991. Then, in a recent email to all Microsoft employees, he said the company faces "significant challenges in the near and mid term" from freeware software including Linux and OpenOffice, and that Microsoft's customers had "less passion and enthusiasm for technology."
Similarly, Michael Dell, according to The Wall Street Journal, "sold almost $300 million in shares in late May, compared with more than $120 million of shares sold during all of last year... Mr. Dell in the past has bought shares when he thought they were cheap, according to an executive close to him, and sold them when he viewed the shares as expensive. This could suggest that his recent move stems from a belief the company's recent runup may not be warranted."
Overall, according to the same article, "More than $3.1 billion in shares was sold in May by corporate insiders, the most such selling in 24 months." Insider selling has been an excellent indicator of upcoming corporate woes: "On the 14 occasions when there has been as much selling relative to buying as in the past month, the Standard & Poor's 500-stock index has on average fallen 6% in the subsequent six months and 9% in the following year, says Lon Gerber, director of insider research at Thomson Financial."
In contrast to insiders, the behavior of average investors tends to be a great contrary indicator -- in other words, when investors are exceedingly bullish, look out below! The latest data does not bode well for the market, as the Investors Intelligence survey released this week showed bullish sentiment among financial newsletter writers rising to 56.5% -- the highest level in more than two years -- and bearish sentiment falling to 20.7%, the lowest level in 12 years. (Go to this website to see for yourself what a good contrary indicator the survey as been.) Similarly, the American Association of Individual Investors member survey last week showed bullish sentiment at 62.9% vs. only 14.3% bearish.
Maybe this time will be different, however, and the average investor's bullishness will be fulfilled by a resurgent economy and soaring corporate earnings. There are indeed some reasons to be hopeful:
- The Conference Board's index of consumer confidence, after falling from above 140 in 2000 to around 60 amid war fears in March, has surged in the past two months to its current level of 83.8.
- While there are a few troubling signs, the housing market overall remains robust.
- Interest rates remain at multi-decade lows.
- The Institute for Supply Management index of nonmanufacturing activity rose to a four-month high of 54.5 in May and the Purchasing Management Association of Chicago index of area business activity rose to a seasonally adjusted 52.2 in May, up from 47.6 in April (readings above 50 are considered indicative of expansion).
- The Labor Department reported this week that nonfarm business productivity rose at an annual rate of 1.9% in the first quarter, up from 0.7% in last year's fourth quarter.
- Bank of America, the largest lender to individuals and companies, said that demand for commercial loans was accelerating.
- Oil prices have dropped 25% since early March.
- In the past year, the dollar has fallen more than 30% against the euro, boosting American companies' competitiveness vs. their European counterparts.
- There is some reason for optimism on the geopolitical front.
- The recent tax cuts will likely provide some stimulus.
Citing many of these factors, Alan Greenspan, the chairman of the Federal Reserve, concluded this week that the economy had "stabilized" in May, that he saw "the makings of a turnaround," and that growth would "quicken" in the third quarter.