How to Fix the 1997 Parallel We're In
Address the credit default swap market at the root.
The incessant selling of great reports is as bad as I've seen since... 1997. I bet you were thinking that was going to be a different year. Anyway, yes 1997, and during that time we saw former tech stars like Sun Microsystems (JAVA), Ascend Communications, JDS Uniphase (JDSU), Novellus Systems (NVLS), Cisco (CSCO), Microsoft (MSFT), and a host of others all trade for PEGs below or well below 1. Sun Micro in particular at one time had a PE of 14 and EPS growth of 25%, which turned out to be hugely conservative. Needless to say the stock went on a humongous run after a tough few months. As did all those others mentioned above.
While that year and 1998 get a little historic press, we had a series of corrections over a two- to three-year period with one doozy in 1998.
Bottom line, I see many parallels between then and now, though this time the market is actually cheaper on a few fronts. First, it's notably cheaper on the ratio to bond yield levels. It's also cheaper on PEs and PEGs if these huge net cash positions are stripped out. Interestingly, another parallel is the tension associated with foreign jitters and broadly the derivatives markets.
In the end, the jitters of 1997-1998 gave way to the earnings bubble of the Y2K, Internet, and bandwidth growth segments and many new highs were created, ultimately culminating in the 2000 tech stock bubble. So what happens this time?
Well, back then, the Long-Term Capital Management and Orange County and the Russian currency crisis were fixed and thus the earnings power was able to come through to stunningly higher stock prices.
The same potential exists today. The latest wrinkle isn't about Greece or Spain or the UK or US. It's more about the CDS market. And this is fixable, I think quite easily. Sure all these countries have higher debt levels but they always do coming out of trough economic cycles and coming into growth phases, revenues increase, tax receipts increase, and voilà, debt and deficit reduction. Just look at the tax collections from the top 50 in the S&P 500 after this quarters earnings results.
The fix has to address the root. And, I believe if we do that, the gains in the various global markets (especially US, Germany, Aussie, and UK) will be similar to what we saw post the last 1997 market correction.
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