There are many models to value stocks, but the bottom line is that stock prices rise if money is moving into the market, fall when money moves out. For most of the 90's, money flowed out of savings into stocks and stock mutual funds, and through automatic investment programs such as 401Ks. In particular through early 2000, investors and fund managers wanted to be in emerging technology companies associated with the Internet boom, and many unseasoned companies were brought public prematurely. Employees of these companies and the venture capital companies which backed them naturally wanted to cash out as soon as lock-ups expired - with a lot more stock available for sale, the group as a whole collapsed starting April 2000. We didn't have a problem with that - we didn't have investments in companies like IVillage, VA-Linux and Pets.com and the fact these companies fell 95% or more from their peaks was no surprise to us.
However, if you were a private investor on margin or an aggressive fund managing facing redemptions, you had to raise cash. Since little value remained in the emerging growth companies, established blue chip companies like Sun Micro, EMC and Oracle were sold. Combined with tax loss harvesting, the broader market fell sharply in Q4 2000.
January brought a relief rally. However, interest rate increases from last year caused economic growth to slow from a blistering 7% to 1%. Corporations faced a downturn in earnings growth for the first time since 1994. In prior years, a CFO would make a private call to a friendly Wall Street analyst to talk down numbers. Such conversations are now prohibited under a new SEC "Full Disclosure" rule. Instead, companies have put out 4 times as many negative "pre-announcements" this year as last year. Since all investors react to these announcements simultaneously, stock prices get crushed. We thought all the bad news was out by early March; instead stocks prices fell 15% by month end.
We expect additional selling through April17th as cash must be raised to pay taxes on gains realized last year. Regular earnings reports are due starting April 9th - any company which fails to meet lowered expectations will see its stock knocked down. Company managements and Wall Street analysts are having a terrible time forecasting earnings and revenues right now, but the consensus is that earnings will fall 7.2% for 1Q01, and 5.2% for 2Q01, but rise 2.7% for 3Q01.
The drag on earnings is less from inventory buildup (modern companies are very good at inventory management and consumer spending is still strong,) more from an excess of capacity building (we have too many phone companies, too many factories, too much bandwidth.) After a 5-year capital spending spree which has sharply boosted US productivity, US businesses are now sidetracking new projects until conditions are better. Widespread layoffs are now the norm after a 7-year absence from headlines.
Our accounts fell 11.9% on average, the worst performance in 8 years of business. Normally we can count on losses in the volatile tech stocks to be offset by gains in financial services and healthcare, as we saw in 2000. This quarter, all three sectors fell sharply. Losses were mitigated in those accounts with fixed income exposure (up 2.75%). Our energy stocks were down 3.3% and REITs were down 1.7%. It seems that once every half generation or so, the stock market must undergo a cataclysmic downturn (the last was in 1987). If so, now is a fairly low risk time to be invested in stocks.
We certainly don't foresee another quarter as grim as the one just past. Also, economic growth will pick up to the 3-3.5% level later this year as Fed rates cuts boost output. Consumer spending (2/3's of the economy) and confidence remain high, and low mortgage rates put more money into consumer hands than any tax cut. Corporations will struggle for a few quarters, but the stock market generally anticipates conditions by 6-9 months and stock prices will move higher. Our forecast for year-end S&P 500 is 1300, NASDAQ at 3000. These estimates are in line with most Wall Street strategists.
Best regards,