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10/21/02  

Framing the Bull/ Bear Debate (8/19/01)

Let's start with the bear arguments. Technology is a cyclical play. We need to eliminate the notion that technology was in a super cycle with uninterruptible growth beyond the horizon, with any multiple of revenues or earnings justifiable. Remember, in the early 90's many of the big names could be had near single digit P/E's. 

While technology will reconstitute itself, there are no names that are not in highly competitive areas, and the old winners may become very low multiple names. Witness the price behavior/ multiple contraction of prior winners like Apple, IBM, and others as the a business segment gets competition, loses pricing power, and growth slows. Some of the big names below are in the early stages of this realization. Despite 50% to 80% price declines, current prices are still not cheap. Let's take a look at some numbers. I would maintain forward estimates are highly suspect as the analysts are the last to clue into problems. 

Some of the more cyclical areas like semiconductors are clearly not valued like other deeper cyclicals. There is a certain elan with technology that supports new age pricing, while old economy names in metals, or oil service wallow at far lower valuation levels. 

Another critical point is that technology must constantly reinvent itself. Many companies do not get true full product cycles (required to recover product development costs) because the marketplace requires significant/ constant changes to meet customer needs and competitive enhancements. While the revenues are earned, the costs of evolving the product  many times are capitalized. In other words, the notion of free cash flow simply is an illusion. If all software and product development costs were expensed, valuations multiples would be higher. 

Finally, the old economy stocks are fully valued. We are poised on the brink of an intractable recession with nothing but downward revisions in our future. While profits will recover, that fact is already in the price of these non too cheap names. Fed rate cuts and tax refunds have not arrested this downhill slide. At a minimum, we will test the April lows, and probably break below. At that point, the depression will have descended and we will be looking at some very bitter unforseen events such as the world economy tilting to the left for some old fashioned socialist cures. Wake up and smell the dead carcasses.

The Bull Case

This case is basically that we may test the April lows by October, but that we will bounce strongly as the economy and technology respond to rate reductions and business restructurings. We will get the frequent pattern of short covering, cash deployment and then underinvested money manager panicing to get involved. We will get amazing volume and breadth and we will be off to the races with 3000 a good NAZZ target and the DJIA at 11,200 or more. Get positioned over the next 8 weeks to get a bust out rally. 

Look, bear market normally last only 10 months and we are working on 17 months. Bear markets normally take 25%  off equitie values. We are over 60%. If we need to regress to the mean and really suffer a huge hangover, the market has met the requirement. Enough already. Just like everyone got sucked into the bullish, greater fool market, those same investors are going to cash now. They will always get it wrong. 

Put/call ratios are spiking over 1 and sentiment could not be worse, or more propitious for long term investors. Low price levels are a function of efficiencies, not lack of demand and this is a good news story. 

We are merely setting up an unbelievable buying opportunities with low interest rates, bearish sentiment extremes, and significant shorts and cash. Technology is not dead and will resume its rightful place and drive our economy again. Those who accept the bearish thesis will get sucked into taking huge losses, and missing one of the great buying opportunities. History is on the side of the bulls. 

End

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