“Big bottom…big bottom… How can I leave her behind…” Spinal Tap
Of all the market events and chart formations that investors cherish, none is so appealing as the Big Bottom. It is like the moment in a dipsomaniac’s life when he finally realizes that he cannot continue as he has. After what might have been decades of decline, he arises from the gutter… stumbles over to the nearest Presbyterian church, where at that very moment, if he is lucky, an Alcoholics Anonymous meeting is taking place. From that moment on, his life can only get better.
I had thought that Mr. Deshais, our gardener, had been through this process recently. Unshaven…rumpled…he had begun to look like a day trader… And in the spring, he reported that he had been thrown out of the house…and reduced to sleep in the fields.
But since August he had seemed more alert…and more chipper. His pants seemed zipped up more often and his eyes were clear.
Then, one day recently, he came over – not on his moped, which has been his customary form of locomotion since the local gendarmes took away his driving license – but in an automobile. Along with him, a middle-aged woman who showed signs of considerable wear and tear but was otherwise not unattractive, emerged from the vehicle.
“This is Madame Deshais,” he introduced me.
Elizabeth and I were happy to see that Mr. Deshais had put his life back together and was once again living in conjugal harmony. Alas…in life, as in markets, Big Bottoms, do not come along every day. Mr. Deshais wobbled badly last Sunday…suggesting that the Big Bottom is still in the future, and that his August to November rally is over.
“So where do we go from here?” asks Brian Durrant in the U.K. edition of our Fleet Street Letter. “There are two scenarios. The first is that the Nasdaq is undergoing a healthy correction and that bargain hunters will help form a platform from which the Nasdaq will recover as it did towards the end of last year. After all, Intel and Microsoft have touched multiples of 25 and 28 times earnings respectively, levels not seen for quite some time.”
“The second scenario,” says Mr. Durrant, “is that this is only the beginning of the meltdown in tech stocks.”
Either we have seen the Big Bottom…or we have not, in other words.
At a bottom, everything gets better. It is a no-lose situation for investors. A no-brainer. A bottom is a bottom. It doesn’t get any worse. So it can only get better. Prices improve. People make money.
On the backside is the best possible place for investors to be. There is no downside. Only upside.
The bulls think they see bottoms everywhere. Stockpicker Al Frank on November 1st: “I feel that the bulk of this year’s correction has run its course and that we will see a powerful November-December rally…”
Harry “Dow 35,00” Dent warns that we haven’t quite gotten to the Big Bottom…but he can see it coming: “It will probably get worse before it gets better,” he said to a Barron’s reporter in early November. “We have been warning since the start of this year that the Nasdaq composite could test new lows, possibly dropping down to the 2300 level.”
But at that point – it’s Bottom City according to Mr. Dent: “…that would end up creating a tremendous buying opportunity…”
According to Barron’s, Dent’s outlook did not stop his funds from making “major bets,” at the end of August, on stocks such as Intel, Cisco, Nortel and Oracle.
Dent must have confused his stock market anatomy. A bottom is the low point. A top is at the other end. Cisco, Intel and Nortel were selling as though they were at a top, not a bottom.
A bottom is far better than top. In fact, it is the mirror opposite in every way. At a top, everyone is bullish. Happy. Optimistic. That’s when they buy the market leaders – such as Intel and Cisco – at prices that can hardly even be imagined at a bottom.
At a top – all the good news is out. All that remains to be disclosed is the bad news. And the only way the market can react is negatively – downwards. An investor cannot win at a market top – unless he is brave enough to sell short. Contrariwise, at a bottom an investor cannot lose – that is unless, he is foolhardy enough to sell short.
Is Microsoft a bargain at 28 times earnings? Is all the bad news out? Is there only upside?
“Microsoft’s stronger-than-expected quarterly results do not necessarily make it a bargain,” Mr. Durrant continues. “Closer examination of the accounts suggests that Microsoft’s growth rate is maturing into the 10% – 15% range not untypical of successful, old-economy stocks.”
Do successful, old-economy stocks sell for 28 times earnings at market bottoms?
P/E multiples tend to be very high at market tops and very low at market bottoms. In 1948 P/Es were at the bottom of the range – with a median multiple of 5.8. Then, the bull market of the `50s drove up the multiple to 19.4 by 1961.
Stocks collapsed in 1968…but then something funny happened. By 1970, investors thought they saw a bottom. Ignoring most of the beaten-down stocks of the time, they bought shares in the leading growth companies. This created a confusing picture – the `two-tiered market’ of the early 70s. Most companies continued falling in price…and sank to P/Es of 5 and 6…but the top growth companies – known as the `nifty fifty’ – soared. By the end of March, 1973, these 50 companies had a median multiple of 48.4.
One of the great growth companies of that era was Avon Products, which at one point had a market value greater than the entire steel industry. But by 1973 Avon’s growth rate had declined – like Microsoft’s – to something rather ordinary, between 15% and 20% per year.
What happened next?
“The destruction of the Nifty Fifty,” writes Marc Faber, “which followed in 1973 and 1974, was extremely severe…a very large number of stocks…collapsed by 80% or more.
“After 1968, the U.S. stock market sold off until May 1970,” explains Faber, “from where it rallied to a new high for the Dow and the S&P 500 in January 1973…However, if we take into account inflation as well as the more than 30% depreciation of the U.S. dollar between 1971 and 1973, then the high of the US market was not in 1973, but in 1968.”
The false bottom of 1970 proved deadly. David Dreman has pointed out that 150 money managers were asked to pick their top five stocks for the coming year. Their favorites: companies such as TWA, Polaroid, Burroughs and Levitz Furniture.
By early 1973, some of the top picks had fallen by as much as 60% and new choices were made. By the end of the year, they were down a total of 67%. Polaroid lost a total of 85% of its value. Levitz Furniture lost 95%.
Another way to search for bottoms is by looking at the returns stocks give investors. Over the past 100 years, not including dividends, investors have gained about 5.3% per year. But, as Richard Russell explains, the Dow has given investors an unusual rate of return of 24.6% for each of the last five years.
Investors do not typically enjoy 24% annual rates of growth just before hitting a market bottom. Instead, such growth normally proceeds a top. The rate of growth you would expect at a bottom would be negative. After a few years of negative growth, you might expect stocks to hit bottom…and begin to recover. After years of above-average growth, on the other hand, you’d expect that they would top out…and slow down to the 100-year mean.
Getting back to the mean now, Russell points out, implies a one-year drop in the Dow of 54.6% or no Dow gains at all for the next 16.3 years. Thus, you could expect the bottom anywhere below Dow 5,000 – or, in the year 2016…whichever comes first.
With best wishes to you,
Paris, France November 24, 2000
*** Not much news today. Markets in the U.S. were closed for Thanksgiving. Foreign markets barely budged.
*** The euro stayed about where it was on Wednesday.
*** You may have noticed in the figures I gave you yesterday that stocks in builders have done pretty well this year. I suggested a few early in the year; I hope you were able to take advantage of them.
*** But there are still some `darned cheap’ stocks among the builders. Fund manager Jeff Gendell, interviewed in Barrons, makes some recommendations: Kaufman & Broad, the biggest of them, is expected to earn $4.50 a share in the coming year. You can buy the shares for just $30 – a P/E of less than 6.
*** Meritage Homes stock almost doubled in the last few weeks. Still, the P/E on next year’s estimated earnings is barely 5. Ryland should earn $6 and shares are selling for about $36.
*** Or how about an ugly, polluting coal producer? Coal is decidedly d?mod?. Ambitious young men do not dream of making their fortunes in coal. Nor do you find many coal billionaires on Forbes’ lists of the richest people in the country. In fact, my own grandfather was in the coal business in the 1920s – and went broke in the depression.
*** Still 55% of the nation’s electricity is generated from coal. And with prices of gas and oil double and triple what they were a few years ago – coal is looking pretty good. Gendell mentions Arch Coal and Fluor – about which I have no further information, but they might be worth a closer look.
*** Related to coal is a Dickensian-sounding product called carbon black – used in hardening tires, toner for copiers, and so forth. A company called Cabot makes the stuff, and Gendell expects it to earn about $2 per share next year…and maybe $3 a share in the year following. At $23 Cabot could also be a reasonable buy.
*** At least Cabot’s management thinks the stock is a buy – they recently announced a 10 million-share buyback program. Buying your own shares makes sense – when the shares are cheap.
*** By contrast, Cisco systems is setting new records for the number of shares it lets loose on the world. Currently, notes Jim Grant, the 7.5 billion shares outstanding is equal to “more than one share for each of the planet’s 6.1 billion people.” But printing your own `currency’ is a hard habit to break. Even as the value of each of Cisco’s reichsmarks, I mean shares, falls…Cisco’s managers keep creating more of them. Analysts were told to expect further dilution of at the rate of 80 million more shares per month.
*** DR reader, FM, wrote to tell me that another dot.com, Garden.com, bit the dirt. The stock flowered at $13 last year, but withered to less than $1 this week. The company said it would close its doors and lay off all employees.
*** The future looks bleak for the Internets. Even Henry Blodget seems to have re-invented himself as a dot.com realist. The pure e-tailers, he notes, have a very hard time competing against the big `clicks and mortar’ stores – such as Wal-Mart. “If they wanted to give away product for free for the next five years they could,” said the Merrill Lynch mountebank.
*** This Christmas season probably represents a `make it or break it’ period for many of the e-tailers. For the most part, they’ve stopped spending money on foolish image advertising. They are conserving cash, switching to more efficient direct marketing techniques – and hoping to prove that they can be profitable in this shopping season.
*** But meanwhile, reports suggest that sales growth online is slowing. And big, old-economy retailers – such as Wal- Mart – are bound to be taking more of it.
*** “Retailers with well-established brand names and hundreds of stores in malls have a huge advantage over their purely Internet cousins,” writes Leslie Kaufmann in the NY TIMES. After more than 3 years of insufferable boasting, warning and laptop-thumping from Gilder, Saylor, Bezos and a whole starry-eyed constellation of New Era prophets, Kaufmann concludes: “even big-name retailers, from Nordstrom Inc. to Barnes & Noble Inc. have not been able to show that Internet retailing is anything but a money-losing venture.”
*** This day marks the anniversary of Darwin’s publication of the Origin of the Species.