February 14, 2001: Spotlight
Peaked Peaks? - Part 2
By Brady Willett and Todd Alway
"Rather than representing a temporary slow-down in the growth of equity valuations, current market conditions threaten
to make temporary bearish sentiments into an entrenched bearish reality."
September 20, 2000 – Peaked Peaks?
Back in September the peaks worthy of attention were those of Cisco, the Nasdaq, the Dow, mutual fund assets,
turnover rates, and margin debt. Suffice it to say, since that time not much has changed in equities. Since September,
turnover rates and margin debt, both of which peaked back in March 2000, have continued their descent: margin debt
dropped in 7 of the 9 months following March, and turnover rates fell to a low of 72% in August before rebounding to 97% by December (a record 88% NYSE turnover rate for last year).
Today there are some different peaks to consider. To begin with, the U.S. savings rate may have just struck its inverted
peak. Steep drops in consumer confidence and the shaky U.S. equity markets highlight the need for Americans to save
more. This could potentially be bad news for market bulls because if more Americans begin to save this means that less
money would be made available to the markets. Conversely, perhaps keeping the good times rolling for a little bit
longer, investors have further interest rate cuts to look forward to, along with an undecided sum of tax cuts. The manner
in which this added liquidity is deployed will ultimately determine the future gyrations of the savings rate. Suffice it to
say, only twice in history has the savings rate dipped to negative before; 1933, and 1934. Shortly after this occurred
American's began to save again, primarily because the economic situation did not readily improve.
If equity pressures continue and consumers decide to start saving, the goldilocks economy will be left behind. However,
despite a slew of lay-offs, the labor market is not flashing any ominous signals just yet. Job creation remains robust even
as the unemployment rate has begun to rise off of its all-time low of 3.9%. The labor market, as is often the case, can become the deciding factor in determining how entrenched bearish sentiment becomes.
Further peaks to consider are found in the mutual fund industry. At first glance the industry itself appears to defy all
logic; the crash in 1987 did not scare investors away for very long, and neither has the most recent tech debacle. Amazing.
It is as if we are living in the 1920s and everyone owns investment trusts but no one will sell them. During that period,
investors, who did not typically get involved in the markets, had an insatiable thirst for investment trusts and continued to
purchase them until the bitter end. As we know, the end (the Crash of 1929) sparked an abrupt change in the
investment landscape for many years to come: Investor's penchant for funds did not show its face again until the 1960s.
The fund speculation of the go-go 1960s ended in the 1970s, with severe drops in the amount of funds, and
capitalization. Even though the 1920s, and 1960s have a uniqueness of all their own, today's fund industry has become much more pervasive in influencing stock prices.
Money market funds, and the so-called 'value resurgence' in equities (primarily the Dow) have helped form a capitalization peak in August 2000 that could be a memorable mark.
The average fund investor holds for about two years -- this contrasts sharply with the 1970s when the average holding
period was 12 years. This is largely a consequence of the numerous types of funds offered today, but it also relates
directly to the decline in the savings rate. The not so soft economic landing could throw a wrench into fund growth.
Although the latter half of 1999 will be remembered as one of the most profound investment periods ever for venture
capital, this sector had already begun to display potentially ominous peaks that observant speculators are taking notice of.
Lastly, there is the pursuit of 'value'. It seems almost pointless to reiterate the fanatical P/E valuations, but so long as
large cap issues remain so grossly overvalued by historical standards, then there is little else to direct attention at. P/E
ratios comment on investor tolerances, and growth expectations. Despite the mild tech correction these tolerances are still at records in some cases, even as expectations for growth diminish.
P/E's are merely the tip of the iceberg. What has happened is that other popular numbers have also become historically
high. These numbers include price/cash-flow, book value, and price/sales. Contrary to popular opinion, growth in
earnings has not made the bull market possible. What has is the uncanny desire of investors to obtain stocks no matter what the economic situation or statistical indicators might suggest.
Stocks are worth what people are willing to pay for them, and all the peaks and statistics in the world cannot defeat this
premise. There is more to figuring out this game than debt, and current account imbalances; despite the recent decline, the financial markets are still doing things they have never done before.
Peaked Peaks? - Part 1