April 20, 1999
Dow Jones Average: 10441
S & P 500 Index: 1289
Dow Ten Thousand
Extremes have become the norm in the financial markets of today. The
widespread, virtually instantaneous dissemination of financial news
over the internet has democratized the flow of information. Analysts
and opinion makers have seen their influence usurped by the masses who
frequent on-line chat rooms and market oriented web sites. Technological
developments, social trends, and stock price movements are increasingly
compressed into shorter time frames. As a reflection of the times it
is fitting that the Dow Jones Average reached the extreme level of 10,000
in the latest quarter.
The indices measuring the largest companies reached new highs in both
absolute and relative terms. Over the past one hundred and twenty years
of U.S. market history, there has never been a market more expensive
than the current market. All the important valuation benchmarks have
been eclipsed by this historic bull market. Whether one looks at P/E
ratios, dividends paid by companies, price to revenue numbers, book
value, price to cash flow, or the value of the entire stock market relative
to gross national product in the U.S., this market has exceeded by a
considerable margin all the high water marks set in earlier decades.
It would take an extreme decline of fifty percent to bring the market
back to its normal long term valuation level.
The gold rush mentality prevalent in the current market makes investment
theories based on reason and ratios appear antiquated. Price momentum
is the primary market driver. Stocks that exhibit positive price momentum
gain in popularity, while all others are dismissed and abandoned by
investors. Momentum as an investment discipline seems seductively simple
and appealing, until one realizes that stocks suffering the sharpest
declines were yesterday's momentum favorites. Momentum investing is
a fickle style, but increasingly popular with investors who fervently
want to believe that stock prices can rise in geometric fashion forever.
The sustainability of the recent market advance is questionable. We
do not recall major market indices reaching new highs with so many individual
stocks sinking to new lows. The big company stocks have enjoyed a resurgence
from the lows of last summer, but medium size and smaller company shares
have not participated fully in the recovery. High priced markets tend
to narrow as they top out. There is simply not enough money to support
a broad group of overpriced stocks. Y2K
Many clients have asked our opinion on the Y2K issue. We have first
hand experience with the subject, as the Securities and Exchange Commission
sent two people to our office last week to check on our Y2K readiness.
The SEC is reviewing the Y2K readiness of all managers, including firms
such as ours that use modern four digit dating software systems. We
in turn are checking on the Y2K status of all our vendors, brokerage
and bank relationships. Throughout the U.S. companies are upgrading
software systems, testing imbedded chips, and running Y2K simulations.
We follow many of the companies that specialize in software development
for larger corporations. From our study of these companies, and the
jobs they are successfully completing, we conclude that major U.S. corporations
are generally in a state of Y2K readiness.
While most people agree with our assessment of U.S. corporations there
is less confidence about foreign suppliers. No one knows if the Y2K
problem is being addressed at firms in Europe, Asia, and Latin America.
Information regarding Y2K readiness is not given out liberally, because
suppliers that are not prepared do not want customers moving business
to competitors. Much of the mystery surrounding Y2K readiness will not
be clarified until the first quarter of the year 2000. There is a psychological
element to Y2K, fear of the unknowable and of technology, that is at
least as important as the reality of a potential software crash.
Current Strategy
The stock market remains in a state of high anxiety. Even as investors
celebrate Dow 10,000 there is a sense that all is not well. Too many
companies of substance are seeing their shares decline while profitless
internet stocks soar. Investors are afraid of missing the boat and equally
afraid that this riverboat casino may be headed over a great falls.
Everyone is listening for a rumbling sound that may signal danger ahead,
but it is hard to hear over the noisy, exuberant gamblers.
We have been researching many of the fallen stocks such as Whole Foods
Markets and 3M ( Minnesota, Mining, and Manufacturing), and have concluded
that a few good buys do exist even in this risky market. The purchases
we made last quarter are already finding favor with those investors
still looking for sensible stock choices. The recent upsurge in these
formerly depressed stocks is welcome, but our enthusiasm is tempered
by the knowledge that all stocks will go down in a major market decline.
We are maintaining a cautious balance between equity exposure and stable
fixed income assets.
