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Jim Stack: Words of Caution
08/29/2002 12:00 am EST
Three years ago at The San Francisco Money Show - the conference that preceded the peak of the market bubble - Jim Stack stood out for his decided bearishness. In his workshop then, he featured a survey from PaineWebber that showed that investors with less than five years' experience expected the stock market to return over 20% annually for the next ten years. His forecast was that we were not in a new era, but a bubble. What does he think now?
"Perspectives have changed dramatically since the 1999 and early 2000 period. Today you won't see arrogant ads from mutual fund companies and books touting Dow 36,000. We've gotten rid of some of the excesses out there. The fact is we have popped a bubble. But there is an inherent problem when you pop a bubble. It comes from lessons that we have learned in past bubbles. And that is the fact that once you pop a bubble it does not easily re-inflate. A lot of people have been disappointed over the past two years, expecting their losing stocks to come back. We should not expect the NASDAQ to get back to 5,000 anytime soon. Or even to 2,000 or 3,000. How do I know that? Historical precedence. Look at the gold bubble in the early 1980s, when gold got up to over $800. Gold is still only at about $300 and that's over 15 years after the bubble. Look at Japan and how that bubble popped in 1989 - after the Nikkei soared towards 40,000. Over the next ten years, the Nikkei is still at less than a third of its level back in 1989. Yes, there have been several profitable bull markets since, but the lesson is that bubbles do not easily re-inflate. In both cases, we've seen that most of the damage is done very quickly, usually in the first one-and-a-half to two-and-a-half years. The problem is that you then have a long period of base building."
"Why is Japan still seeing their market at less than one-third of its previous level 12 years after the market peak? The reason is deflation. In Japan, tremendous value was wiped out, which led to a weakening economy and falling real estate prices. As real estate prices fell, banks got in trouble. At the time the bubble burst, Japanese banks were believed to be the strongest in the world. Are we heading into a similar scenario? Probabilities suggest no. However, the risk of such a deflationary period in the US is the highest in 70 years. We've lost $7 trillion in paper wealth on Wall Street. That's more than the entire value of the US stock market just six years ago. That's frightening. That loss of paper wealth results in a loss of confidence and that takes time to rebuild, and we are still seeing confidence drop. Consumer confidence is on very fragile footing. The survey of purchasing managers - one of the best leading economic indicators - just took its second biggest drop in 18 years. Now that's pretty unusual when you are supposedly five months into an economic recovery. That bothers me. I would also be more confident if global markets looked strong and could help lift up the US. But the Dow Jones World Stock Index (excluding the US) dropped to new lows last month - its lowest level since 1993. That again is a reason to be more defensive and more cautious in today's environment."
"So where are we? Will we see the NASDAQ back up at 2,000 or 3,000? Yes. When? I don't know, because I don't know when earnings are going to come back. Today, the net cumulative earnings of the 4,800 domestic stocks in the NASDAQ are negative. It is hard to stand up here and tell you whether the NASDAQ is overvalued when the bottom line shows that when you add up the 4,800 companies, there are no net earnings yet. I can tell you we will not see the NASDAQ go back to even 2,000 without solid earnings underneath it. It can't float on the hype and hot air anymore. The market is going to have to have true intrinsic value. When those companies start restoring earnings, when you see money flowing to the bottom line, and when investors have confidence, that's when the NASDAQ will come back up. I won't be surprised if we get out a couple of years from now, and we still see the NASDAQ battle to just get up to 2,000. This won't change until you see profits flow through to the bottom line."
"Overall, it's very clear that we have popped a valuation bubble on Wall Street. The seven trillion dollars in value wiped out is significant. It has a greater potential negative impact on the economy than any previous bear market. How do you invest in this environment? You have to allow for the risks that this economic cycle might not be the norm. Don't assume we are in a normal recovery. Conversely, don't feel you have to put your money in a mattress and hide. The Fed has the advantage of having the lessons of Japan. And from a long-term standpoint, I think the Fed still has some tricks up its sleeve. For now, I would monitor consumer confidence. If it continues to drop, I would carry higher cash reserves."
"Don't buy the crashed high-tech stocks just because they look cheap. Also don't go out and buy big cap stocks just because they appear safer. A lot of the big cap stocks are still overvalued. Focus on value. Remember, that p/e ratio does count, and if a stock is paying a dividend that is a bonus. Have some defensive hedges in your portfolio. Look at resource stocks. I also think it's a good time to own stable, income-oriented stocks. Most important, be patient. The next 60 to 90 days will be very important. If consumer confidence rebounds and stabilizes, and if the stock market does not drop to new lows, we'll increase our positions. But if confidence takes another plunge, or the major indexes drop to new lows, I would move back to a higher cash position, because the odds would then be that we are heading back into recession."
Editor's Note: Two days after the speech above was presented, the Conference Board released its confidence index for August, which fell to 93.5 from July's 97.4