FOOL ON THE HILL
For the first time in two years, the major American stock indices have enjoyed some significant sustained growth over a four-week period. Unfortunately, there is very little in terms of corporate performance to undergird this rise in valuations. Some of the biggest gainers are the same companies that were so hideously overpriced last year, and investors need to be sure not to get swept up in another speculative orgy.
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It seems we are looking at a golden opportunity here: We get to discover, in short order, whether the lessons that should have been beaten into us by the brutal drop in technology stocks have taken root. Yes, some of the indomitable lions of the late 1990s are roaring once again, posting gains, in some cases of 100%-plus in only a few weeks. The entire Nasdaq Composite market has risen more than 36% from its lows of slightly more than one month ago. The more widely followed Dow Jones Industrial Average and the S&P 500 have gotten into the game as well, rising 22% and 21%, respectively. Our own FOOL 50 Index hasn't been left out, rising 28% in spite of the heavy weight of the collapse of Enron (NYSE: ENE), one of its component companies, during this same period. By any of the most significant measures, the markets have rebounded quite well in short order, eliminating some of the foul taste many people were beginning to associate with investing. But the rapid rise won't last. It can't, for reasons I'll explain. Not for any of the inane reasons the talking heads give, certainly; I don't buy into any of that "relief rally" malarkey. Neither should you spend a single second convincing yourself that the enormous interest rate cutting by the Federal Reserve is finally going to let the good times roll again. Let me put it to you straight: The good times WERE the problem. There is nothing -- repeat, nothing -- in the operational results of many of the former high-flyers right now suggesting that their stocks shoot back up into instant orbit. Laissez les bontemps rouler? Sure, if they are accompanied by "les bon results," or even "les bon prospects." But out of some wild-eyed theory that we have hit "le bottom grande"? No good, because there is no margin of safety in a rising market that is not backed by business fundamentals. That's a place we've been. While it was fun for a while, the results were generally catastrophic. What the bull market did for many investors was cover up a great many mistakes. Did you feel brilliant when your investment in Juniper (Nasdaq: JNPR) skyrocketed from $120 a share, at 800 times cash flow, up to $240, or 1600 times cash flow? You bet your life you did. Although people point to the performance of profitless companies like Amazon.com (Nasdaq: AMZN) as the primary sign that the investment community had frankly lost its mind, Juniper might be a better test case. Juniper is a company, on many levels, that I would be proud to be associated with, and would be happy to own. It has a product line customers rave over and a management team so highly regarded that well-placed employees at its major competitors coveted Juniper's IPO shares. Juniper's sales through the first nine months of this year were double last year's, and the company is valued at about $8 billion as opposed to last year's $70 billion. In a little more than a month and a half, Juniper stock has tripled, undoubtedly leading some to believe that a return to its dizzying heights of yore is simply a matter of time. Certainly, a company that possesses the qualities of a Juniper -- which, though it is not profitable is generating significant free cash flow -- deserve to be priced richly, but rooting for the stock to skyrocket without some concomitant business growth strikes me as hideously stupid. As it is, Juniper is priced at more than 8x sales. That is a notoriously poor measure, to be sure, but one that should suggest that it has already claimed a rich multiple in a terrible time for telecom spending and despite seeing sales fall sequentially during each quarter this year. In spite of the fact that the cost of capital has been dropped to crack-rock cheap levels, the companies that would be the big customers of companies like Juniper -- as well as the likes of Applied Micro Circuits (Nasdaq: AMCC), JDS Uniphase (Nasdaq: JDSU), and, eventually Novellus (Nasdaq: NVLS) -- are drowning in overcapacity and more than $600 billion in debt. Do we really expect cheap loans to solve these problems? Cheap money is what got us into trouble in the first place. Cheap loans at this point are akin to treating a diabetic with chocolate mousse. Sure, she'll feel better... for a minute. It's easy to be relieved that the shares of companies we own are at long last moving in the right direction, but you've got to remember to ask why they are doing so. I've heard many people say part of the reason for this past month's rise has been institutional movements of money from the bond market back into equities in anticipation of a renewed rise. That's great, but it has nothing to do with business. Neither does the inevitable tax-loss selling that is going to be taking place between now and the end of the year, which is likely to put some pressure on some of the same stocks that have gone up but still sit at a fraction of their highs for the year. These things are irrelevant unless you are actually buying and selling stocks. I've taken some opportunity to purchase and sell a few positions, but beyond that, these events are meaningless. And yet I predict that we will see a spate of wags come out from under their respective rocks and place targets on the year-end value for the Nasdaq, Dow, whatever. Let me repeat myself once again: These predictions are worthless. It's easy to mock Ralph Acampora for his February 2000 prediction of a quick rise to 6000 in the Nasdaq for being completely wrong. What we ought to be pillorying is the fact that he would have the gall to make predictions in the first place. We have just gone through a period in which the stock market has finally penalized a great many investors -- and managers -- for capital allocation mistakes they had been making for years. A rising tide is no time to repeat those mistakes, but rest assured that many people will once again begin to dream of endless, easy riches in stocks if the recent rise continues apace. You may find the allure of high-momentum companies to be quite strong. There is nothing wrong with this. As long as you truly understand the level of your risk tolerance, keep any speculative purchases in smaller denominations than you would be comfortable losing, and do not treat the stock market as something that is separate from the businesses that underpin it, speculation is not unhealthy. It was when people held six technology companies and a biotech "for diversity" and were truly murdered when the market last collapsed. Above all, recognize the lesson that has been afforded you. Six trillion dollars in investment equity in American public companies has vaporized in the last two years. It was not the first time we were swept up in a speculative mania, and it will not be the last. Recognition of this fact may save your nest egg the next time around. Rule one in investing is to protect your capital. There is no rule two. If the markets start to seem too good to be true again, there's a good chance that they are. Fool on! Bill Mann, TMFOtter on the Fool Discussion Boards Bill Mann would like to wish Ol' Dirty Bastard a very happy birthday. The Motley Fool is investors writing for investors.
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