Dow Ten Thousand – April 1999

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.

Return to Archive