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In
our last newsletter, we said that a) our forecasting
model had a target price of 2250 and 1250 for NASDAQ and
the SP500 respectively, and b) over the next 4-6 weeks
the perception with regards to the fundamentals will
begin to change, providing the equity markets with an
excuse for another bear market rally. Well, our targets
were met, and the lowering of interest rates by the FED,
has prompted many to begin thinking “anew” about the
future of the economy and the stock market. However, our
not-so-deep under covered intelligence sources are
reporting to us, that the most debated topic
in cocktail parties, family gatherings, high
school reunions, barber shops, taxi rides etc., is no
longer whether junk like AMZN is going to 400 or not,
but whether this blessed nation of neophyte investors,
uninspiring politicians and not knowing when to quit
-while still ahead- Central Bankers, is going to
recession or not! Of course, the implication is, if the
economy is not going into a recession, then the
market has reached a bottom. Naturally, being
“concerned citizens” ourselves, we feel
compelled to weigh in on the subject with our views and
observations. Our econometric model has produced two
scenarios, one modestly bullish, and one,
not-so-bullish! The first scenario assumes that
the current economic slowdown is a cyclical one, and it
is caused by a temporary satisfaction in demand by
consumers, and a temporary pullback in corporate
spending. Under this scenario, the economy will grow
very modestly in the first half, 0.8% to 1.5%. However,
as lower interest rates, possible tax cuts, and
increased government outlays take hold, along with
the liquidation of excess inventories, the economy will
re-accelerate in the second half of the year growing
about 2.0% to 2.5% in the third quarter, and 2.5% to
3.5% in the final quarter of 2001. If that scenario took
place, then it is reasonable to conclude that the market
has reached a bottom, and prices will generally move
modestly higher, reflecting the modest improvement in
the economy and corporate earnings in the second half of
the year. Our model gives a 32.56% probability of such
an event taking place. The other scenario, assumes that
the current economic slowdown is a secular one, caused
by the end of overspending, over investing, undersupply
and exuberant optimism. To put it simply, one of the
biggest financial bubble the world has ever seen, has
finally burst! In such case, the excesses produced by
the combined orgy of over consumption, overspending and
under saving that lasted by all counts five years
(1995-1999) -and by some counts ten years (1990-1999) -
will take more than just a couple of quarters to be
eliminated. Lower interest rates, and stimulative fiscal
policy, can not be expected to offer much help, because
the returns on investments made during the go-go
years, fail to exceed the original cost of the
investment, resulting in erosion in asset values (due to
a negative rate of return). A good example of this
phenomenon, can be seen in the price of the stock of
telcos. For example, if the cost of long distance service (to
the consumer) goes to zero (as it looks
likely) no matter what the level of interest rates is,
the investment made by telcos in long distance service
will never be recaptured, it must be written off,
eliminated as an asset from the asset section of the
balance sheet, and shareholders’
equity must be reduced accordingly, in order to
balance the balance sheet...! Unfortunately when book
value is reduced, the same happens to the price of the
stock. If this is what is happening with the U.S.
economy then investors should expect several quarters in
which the economy alternates between sub-par growth and
negative growth. Obviously, equity prices will suffer as
well. If this is the scenario currently unfolding in the
U.S. we would expect prices to initially continue
modestly higher -as investors mistakenly convince
themselves that downturn is cyclical, not secular-
However, later in the year, as it becomes evident that
what we are dealing with is a secular trend, equity
prices will head back down again. In such case, NASDAQ
will easily penetrate its recent lows, and we would
expect it to reach 1800-1400 before year’s end. Keep
in mind, that ONLY the excesses in the Internet sector
have been eliminated. Other sectors, such as
biotechnology, fiber-optics, networking are still richly
valued. If such scenario took place, investors should
expect stocks such as BRCD, GLW, JNPR, BRCM, IPDH, GENZ,
etc, to trade at levels ranging between 50% to 75% lower
from current levels. Our model gives a 53.23%
probability of such event taking place.
Our
Market Positions:
Dow: Neutral ,SP500: Neutral
NASDAQ:Neutral
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AEGEAN CAPITAL GROUP INC.