Market Watch (Archive)

In the Fall 2001 issue of IFBW, we cited research that had shown that historically, the broad stock market indices had risen on average 6.8% three months following a variety of past earth shattering events. That is, even allowing for the dramatic sell-offs triggered by the events, the markets eclipsed the losses and then went on to gain by nearly seven percent point-to-point in time. Now (Dec. 5) almost two months after the terrorist attacks of 9/11, the S&P 500 is up 6.3%, or nearly matching past experience since the close on September 10. Even more impressive are the gains from the interim lows hit on September 21. The S&P 500 and Nasdaq composite have rallied by 20% and a torrid 42% respectively. The Nasdaq has dramatically outperformed the more senior index because the latter is heavily laden with technology stocks, which have led the charge.
The technology sector of the S&P by itself has rallied approximately 40% so far in the 4th quarter. Morgan Stanley analysts surmise that, if the sector performance holds up, this would be the fourth consecutive year where absolute gains by the sector will have exceeded 30% in the quarter. Those same analysts scratch their heads regarding the sharp surge of tech stocks, because they project that aggregate earnings for the sector aren’t likely to return to year 2000 levels until 2003. They further point out that price-to-earnings ratios currently placed on tech stocks are already approaching 50X forward earnings, or levels witnessed during the speculative dot.com “bubble” period. Put another way, the sector as a whole appears to be already discounting prior-peak earnings.
Why the seeming return to irrational exuberance? We could argue that the explanation is rooted in the fact that labor productivity has held up better than expectations. According to a recent study by Lehman Brothers, the present recession is likely to be the first since 1960 where productivity on a macroeconomic basis actually improves in the face of overall weakening GDP. Drilling down, the large-capitalization technology companies especially have exhibited excellent cost control during the past several months as orders and shipments have been ravaged by the sharp deterioration of corporate confidence. We would further argue that revenues per employee will recover dramatically when the economy rebounds, which we project should occur during first-half 2002. Cisco Systems CEO John Chambers is reported to have said recently that his company expects to set record sales per employee within the next couple years. We recognize that not all high-tech companies are as uniquely positioned as Cisco to benefit from recovery, but several key players, including Intel, EMC, Sun Microsystems, Microsoft, and IBM, to mention but a few, should demonstrate significant improvement in their respective profit margins well ahead of the rest of the pack, and before 2003, in our opinion. The point is that the equity markets have generally served as leading indicators of future trends, and this time they are suggesting that 2003 high tech profits may be much better than current expectations.