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July 14, 2003 |
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Patience may well be a virtue, but as Shakespeare once offered, “Who can be patient in extremes?”
*Nonfundamental Reasons For The Rally Notwithstanding the use of accounting chicanery, as corporate earnings rise so should stock prices. Such is why – if stock prices were previously ‘fairly valued’ – you could argue that the market should be higher today than they were in Feb/Mar. After all, First Call estimates that 1Q03 profits were up 11.6% (versus estimates of +8.8% on Feb 1), and 2Q03 profits are expected to end in the +8% area. However, and as is often the case, investors have tried to stretch good news (e.g. profits are not in freefall anymore) into great news. In order to accomplish this leap of faith alternative methods of valuing stocks arise. There can be little doubt that the main ‘nonfundamental’ way of justifying recent gains in stocks has been the growing belief that the relationship between risky stocks and safe bonds (see ‘equity premium’) has been profoundly altered. The logic being that when you combine Bush’s reduction on dividend taxes with Greenspan’s assault on interest rates, that stocks must be the highly preferable investment (compared to bonds). The only comment that should be made on this matter is that stocks carry risks while U.S. Treasury’s do not: simply because interest rates are not considered ‘attractive’ – as Japan is well aware – this does not mean that stocks are attractive by default. To note: I call the stock/bond relationship ‘nonfundamental’ because one does not have an absolute impact on the other. To be sure, even if the average stock was yielding a higher after tax dividend return than the 10-year Treasury – which it is not! – this would still not be a fundamental reason to buy stocks. Rather, stocks are fundamentally attractive when valuations (P/E, P/B, ROE, etc) are below average or at reasonable levels, and the earnings/cash flow outlook for a company is solid. With this in mind, consider an article from Glassman entitled “Bubble or not, neglect tech stocks at your peril”. This article begins by referring to legendary investors Benjamin Graham and Warren Buffett. However, before the article is complete, Mr. Glassman completely ignores everything Graham stood for, and nearly everything Buffett stands for: “I don't take P/E ratios for tech stocks too seriously…Even with a P/E that is close to 100, eBay, since it is growing so fast, represents good, though not spectacular, value…Yahoo presents a similar profile” “The best idea to own a diversified portfolio of techs; some will be big winners, the way that Dell Computer (DELL), eBay and Microsoft have been; others will be big losers, but on balance, you should do well over time.” “Even if this may not be the precisely perfect time to invest in high tech, you should not neglect the sector. If you bailed out during the long and sickening slide, you should get back in.” To begin with, neither B or G ever took a diversified approach to investing. Rather, each investor bought what they believe was undervalued and likely to offer a no risk return in the future. Period. Furthermore, B or G never ‘bailed out’ or ever tried to ‘get back in’ to any stock investment. These investment approaches, even by Glassman’s logic, do not work. As for Glassman not taking P/Es seriously – a statement that sometimes can make sense even for a Buffett (not for a Graham) – Glassman fails to expand upon what ‘since its growing fast’ means (if anything). Not only are the quality of earnings for companies like Ebay and Yahoo questionable (what with unexpensed stock options helping each company report profits instead of losses) but the most optimistic forward estimates do not show either company as overly attractive (May 28-Word). In short, Glassman is not unlike Kudlow: he is walking around with a smug grin on his face dying to say I told you so (that stocks would rally) but trying to justify his bullishness by vaguely talking about fundamentals. Glassman does not invest by the fundamentals – but by his unwavering belief that the markets are always going to rally in the future. Give the Glassman’s credit for being stubborn enough to hold onto their convictions, but don’t give them credit for being right. To be sure, Glassman was touting tech stocks as ‘defensive’ in 2001, and he will likely continue touting the Ebay’s even as they inevitably crash back down to earth. That he touts and then mentions someone like Graham - who was a strict valuations (break-up value) investor - is appalling. What the Glassman’s need to understand is that the Fed has thrown patience out the window, embraced extremism, and this is only nonfundamental that matters to the markets. And while everything equities related has come up aces with the Fed is rigging the deck, if the U.S. economy does not soon recover … |
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