Buy on the Dip? or Is the Bear Still Hungry?

2001 has started off as a most challenging year after the bursting of the largest financial bubble in history during the latter months of 2000.

Want to buy on the dip? Well now we have one.

The Nasdaq Composite’s high was 5048.62 on March 10th and fell to 2470.52 for a drop of 51% by December 31st. It rose 15.7% in January but gave virtually all of that back by closing at 2470.97 on February 9th. On February 20, 2001 the Nasdaq closed at 2318.35.

The three major stock indexes gave up all their 2001 gains by February 9th despite the two Fed rate cuts in January and a strong rally in the tech stocks.

The problem is whether today’s markets reflect 100%, 50% or 25% of the dip.

Managing your own investments in these “Don’t try this at home!” markets can be likened to trying to surgically remove your own appendix.

WCBS radio informed us on February 5th that the average account size at brokerage firms E-Trade and Ameritrade is now $20,000 versus $40,000 a year ago and that business is very quiet.

CNBC has lost a significant portion of its audience and reported that a year ago people thought they were watching “a Frat Party” when stock trading was characterized as “legalized gambling” whereas now they seem to be watching “a Tea Party.” Four percent of its staff is being laid off.

January’s announced 142,208 job cuts was the highest monthly total ever recorded according to Challenger, Gray & Christmas, Inc. (IHT 2/17). December’s number was 133,713.

And the announcements continue as Xerox plans to lay off 10,000, Lucent 16,000, Daimler Chrysler 26,000, Nortel 10,000 and Goodyear 7,200 to name a few. GE has disagreed with speculation that 80,000 jobs will be lost with the finalization of its Honeywell merger.

On February 1st we learned the National Association of Purchasing Manager’s Index (PMI) hit its lowest level since March 1991, virtually ten years ago, when the U.S. was last in a recession. The indexes gauging production and orders fell to their lowest points in almost twenty years. At the same time Gross Domestic Product was at its lowest level in five years. And consumer confidence in January fell at its steepest rate since October 1990 – very important as consumer spending accounts for two-thirds of the economy.

The U S economy grew at a rate of 1.4% in the fourth quarter of 2000 – the slowest rate in 5-1/2 years.

The Federal Reserve has lowered interest rates by a full percentage point in less than a month. The target for the federal funds rates was lowered by 50 basis points to 6% on January 3rd and by another 50 basis points to 5-½ % on January 31st. This is the most drastic adjustment the Fed has made in that short a time period since Alan Greenspan became Chairman of the Federal Reserve in 1987.

It’s difficult to find “good news.” Unless one considers “good news” to be the guesses by the hucksters that everything will be OK beginning in the second half when everything will once again be “onward and upward.”

We are reminded of Little Orphan Annie who years ago explained: “It’s not that the snow’s so deep. It’s that my legs are so short!”

Since last March, the dot.coms, Internet related stocks, former high-flying IPOs and a myriad of others have returned to earth from their stratospheric highs resulting in losses amounting to Trillions of dollars.

A number of “good” companies have also sold off very substantially as investors and former investors were, as is always the case with a bursting bubble, unwilling and/or unable to separate the wheat from the chaff.

A review of our Commentaries, especially for the last year and a half, will show numerous warnings about the problems inherent in excessive speculation and the incomprehensible valuations being put on New Economy Companies’ shares by many former investors. However, many valuations, in our opinion, are still excessive despite their fall.

A year ago in our February 3, 2000 Commentary “Strong as Mary’s Breath” we wrote: “We admit to having misjudged the prices people have been and continue to be willing to pay for many tech, biotech and internet stocks.”

Then we quoted the January 18th Wall Street Journal: “Euphoric valuations are hardly the preserve of the Internet. Fifteen technology stocks are today worth more than the entire market a decade ago. All stocks put together are worth a record 172% of U.S. economic output, more than double the level before the 1987 plunge.”

A short time later the unprecedented market run-up leading to the greatest Financial Bubble of all time crested around mid March 2000. We remember the old axiom “Don’t ever confuse genius with a Bull market.”

Percentage gains and losses can be misleading. While a 20% change either up or down on a 100 stock is 20 points, the consequences of being up 20% or being down 20% are very different.

For example, I would be most pleased to have my favorite stock go from 50 to 100 producing a 100% gain. I would be unhappy if it were then to drop 50% from 100 back to 50. A gain of 100% from 50 would be necessary to offset the 50% loss to get back to 100.

Another example: If my stock had dropped from 100 to 20, an 80% loss, I would then need a 400% gain to offset the 80% loss to get back to 100. If I were down 90%, I would need a gain of 900% to get even. If it dropped 100%, I would be a true long-term investor.

The above examples illustrate the importance of attempting to reduce or control losses. That is why we strongly emphasize the objective of Preservation of Capital.

Inflation continues to be minimal; and, as mentioned, the Federal Reserve Bank has begun to sharply lower interest rates reversing a trend of several years. Although the Greenspan/Federal action will take time to work through the system, it will become a positive for the economy and the stock markets. The same will be true of a decrease in income taxes if such legislation is enacted.

It is important to understand, as we close out the second month of 2001, that as a result of the violent shakeout of the high-flyers, the stock markets have cooled to such an extent that now there are stocks having a more favorable risk/reward ratio than there has been for a long time.

Nevertheless, since we are not in the business of catching falling knives and since it is foolish, if not impossible, to predict the bottom, we will remain cautious until we see signs of economic stabilization. All stocks do not go up at once and high quality bonds having a short to medium maturity remain an attractive alternative.

We smell a Bear and hope it will be a cub.

John, W. Hamilton
February 21, 2001