In light of the recent technology boom and bust, James Abate advises investors to look at the larger picture when it comes to making investment decisions
When popular opinion is herd-like, it is usually fully reflected in stock prices and, in many cases, a classic contrarian sign. Time magazine, for example, widely circulated in the US, has been an excellent barometer of popular opinion and a leading indicator for the subsequent change of fortunes on several occasions.
The most recent case was Time's selection of Jeff Bezos, Amazon.com's founder and chief executive, as its Man of the Year for 1999. The issue hit newsstands in January 2000 and nearly marked the peak in internet stocks globally.
Other Time Man of the Year gaffes for investors include Andy Grove of Intel in 1997, right before the Asian crisis severely crimped Intel's profits. It also named the personal computer as the 'Machine of the Year' for 1992, close to the peak in most PC-oriented stocks, the King of Saudi Arabia in 1974 just before the oil crisis mitigated, and the President of General Motors in 1955 when auto companies began their downward slide against the forces of organised labour and imports.
It is easy to poke fun at the consensus opinion when perfect hindsight allows us to. But seriously, gauging the life cycle of enthusiasm, particularly as it relates to technology stocks, can be helpful to investors in the US equity market.
During this year, the psychology surrounding technology stocks has swung widely between doom and gloom and rays of improvement.
Despite such volatile emotions, there is still the overwhelming belief that technology has to be the next leadership group of the market.
This view is particularly strong among the crowd of technology-focused portfolio managers who still control a lot of money despite the drubbing received over the past eighteen months.
The complete despair that existed in late March provided a great opportunity to participate in a reflex rally off the bottom as the Federal Reserve made its surprising inter-meeting interest rate cut.
However, we have passed through the snap-back rally phase and seem to be moving from a focus on Alan Greenspan to attempting to time the turnaround on future earnings.
The internet revolution has brought tremendous benefit to many ' from consumers to the venture capitalists who financed it. Similarly, the personal computer revolution of the early 1980s displayed many of the same attributes. For instance, companies like Apple Computer and others reached frenzied peaks much like Amazon did nearly twenty years later.
In fact, articles from the Financial Times in 1983 argued that only 10 or so 'high-tech' companies would eventually survive. Astonishingly, this fortune proved true as the next few years witnessed a dramatic slowdown in capital spending, most notably in the information technology arena.
Stocks like Apple Computer fell from their early 1983 peak by over three-quarters and did not surpass this price until 1987 when corporate and consumer spending on personal computers was revitalised by new graphical interfaces and a general profit recovery globally.
Related companies in software, hard disk drives and others never recovered, as the aftermath following the boom was too much to bear. This all sounds pretty familiar. In fact, it should serve to frame expectations for today's investors. Investors in Apple Computer back in 1983 were probably the lucky ones because it only took them four years to recoup their capital ' others never did.
Only time will tell whether investors in Amazon will ever recoup their investments made in early 2000 at the peak of internet exuberance. In the meantime, investors who maintain a systematic overweight in technology shares, clinging to the notion that technology must lead the stock market out of its doldrums and will soon return to its former glory, had better be patient.
Investors should recognise that technology stocks, as a group, should now be viewed more as trading vehicles, whereby investors can capture brief yet strong rallies but only benefit by systematically selling into these rallies and repeating the pattern until the end of the economic doldrums is in sight.
So where will the new leadership in the stock market be found? As it stands now, a sharp and dramatic recovery in corporate profits is highly improbable. Instead, we are likely to see the domestic and, perhaps global, economy vacillating in a very undramatic fashion.
That said, the stock market is unlikely to fall far and fast, supported by the favourable liquidity backdrop as investors have the wherewithal to put money to work in equities.
However, the next leg up for the broad indexes is probably months, or even quarters, away. The good news is that a flat market can be very good for active stockpickers. The truth in this fact could not be any more evident as market performance thus far has been broad-based among industries, highlighted by many success stories, mostly turnarounds and transformational companies that are reaping the benefits of specific management actions.
Given that we are likely to plod along for the intermediate future, the best strategy is to remain stock pickers, focusing on select companies that are still in the midst of company-specific restructurings.
Conversely, it is best to avoid those that are mostly dependent upon a sharp economic recovery that, despite the Federal Reserve's aggressive actions, is less likely to materialise in the near future.
Broadly speaking, my best guess is that companies who benefit from falling interest rates and are less exposed to demand cyclicality will do well in the current sluggish environment.
Quality stocks with large capitalisations and definable patterns of earnings should emerge as the market's next leaders.
A drop in long-term interest rates would help mightily to foster such a process as it would likely result in positive re-ratings for this group.
In addition, owning leading companies that hold dominant market share positions within industries will be a winning strategy for the remainder of 2001. This is consistent with an economic slowdown since a further decline in inflation, which is usually characteristic in such a period, should limit across the board price increases, thus favouring the best and most efficient producer in an industry. Most importantly, investors should recognise that we are still in the hangover midst from the heyday of technology overindulgence and now is the time to review opportunities in a wider universe.
• During this year, emotions surrounding technology stocks have been volatile.
• Stocks with definable patterns of earnings should emerge as the new market leaders.
• Investors should recognise we are still in the midst of the technology hangover.
An ambitious objective
'Something completely new'
'Illusion of control'
Reasons to be cheerful
Total investment reaches £9m