The Problem is Investors’ Complacency – Stupid

Here we are with Y2K just around the corner. The advance-decline line (a good proxy for the whole market) on a decline, for fifteen months. Day after day more 52-week lows than highs. And does anyone care? Not the individual investors. They are watching the TV business news and reading the headlines in the newspapers. These sources herald the good news that the Averages have reached new highs. Yet, the truth is, and it was best put by Alan M. Newman, the Editor of HD Brous & Co.’s Crosscurrents when he said, “Consider the following: between the beginning of 1998 and the end of the first quarter of 1999, the NDR Internet Index had roared ahead 176.6% while the S&P 500 rose 25.4%. The broad market of 3500 other stocks fell 10.7%. Was the market really up or was it down? Is this a description of a continuing bull market or of a bear market? Even within the S&P 500, half of the gain came from the action in only 14 individual stocks. Even now, as nearly half of all NYSE stocks trade below their 200-day (10 months) moving averages, the Dow Industrials stand with easy reach of a new record. Like we have said before, some bull market.”

One of the outstanding web sites on the Internet, for those of us that really follow the market, is Carl Swenlin’s Decision Point Alert, which can be found at www.Decisionpoint.com. One shocker of a chart that he developed shows the S&P 500 and its relationship to its normal P/E range of 10 to 20. According to this chart, the S&P 500 is selling at the worst disparity between price and realistic earnings in over 70 years. As he points out, for the S&P 500 to return to fair value, the market would have to correct by 50% or earnings would have to double. Or we could have a combination of the two. What is also very interesting is the fact that it has only been since 1997 that the “reality disconnect” occurred. At this point in time the Averages pushed up sharply while earnings began to decline. Here in 1999 we are seeing, at least for the first two quarters, a return to double digit earnings growth but the S&P 500 P/E is almost 34 times earnings, which is considerably above the historical 15 times earnings. We may have started the catch-up phase; as far as earnings are concerned, but this market needs to pause, it needs a rest. The best thing that could happen would be for the market to move sideways for the next six months. Let’s get Y2K out of the way and corporate earnings increasing, then we should be back closer to a normal value range.

Another area that needs correcting is the perception of expected earnings. Have you ever wondered who these people are with the Tarot cards that can tell what is going to happen tomorrow? In any given quarter they will change their estimates on a company’s earnings half a dozen times, even up to the point that two days before the release of an earning report they and the company are trying to get it right. Why not go back to putting the real emphasis on the gain or loss from the previous year’s earnings? Too realistic for Wall Street?

Gordon B. Lamb
Jeffrey M. Campbell

August 9, 1999