THE SCARIEST SCENARIO IMAGINABLE By Steve Sjuggerud
I never thought we'd see the day... the day when wild speculation actually exceeded the excesses of the late 1990s. And I really didn't think it would just take four years to get there. But here we are...
Investors are actually borrowing money to buy Nasdaq stocks. In fact, more people are borrowing more money to buy stocks today than at any time in history, including the "Great Bubble" of early 2000.
The result? Just like in the days of the Great Bubble, the 'garbage' stocks have soared, while sounder stocks have struggled. A $10,000 investment a year ago in AskJeeves.com (do you know anyone on the planet that actually uses AskJeeves.com?) would be worth $220,000 today. Or how about NetEase.com? $10,000 invested a year ago would be worth even more than AskJeeves...
NetEase.com is valued in the stock market for over $2 billion (with a "b") dollars. Yet sales... yes, sales... over the last 12 months were only $27 million (with an "m") dollars. Who's buying this garbage at these prices? It appears to be individual investors at online brokers...
Trading activity at online brokers in the most recent quarter is up 40% from the same quarter last year. And this is clearly 'hot' money... speculative money... At online broker E-Trade, the level of margin debt in the latest quarter (ended June 30, 2003) among E-Trade customers rose by 31% over the previous quarter (ended March 31, 2003).
It's rampant speculation at its finest.
By contrast, look what corporate insiders - the 'smart money' - are up to. Obviously corporate insiders know more about their businesses than anyone else. Insiders are generally right, but a little early in their selling. Recently, they've been selling at a rate not seen since 1986. They were early back then... but they got out ahead of the Crash of 1987, when stocks fell 22.6% in one day.
Looking at the latest data, corporate insiders set a dollar record for the last decade... insiders sold $44.53 dollars of stock for every dollar of stock they bought. That is unbelievable.
"Insiders, of course, know much more than the general public about their own stocks," Professor Henry Hu of the University of Texas said in a news story on the subject. "Ordinary investors are terribly naive - all they pick up is what they hear from the their friends the financial media. And, unfortunately, investors today still have this pathological fear of being left behind if the market goes up." (Some folks wrongly dismiss this figure, saying that "Bill Gates regularly sells a ton of shares." What these folks don't know is that these figures actually EXCLUDE insider trades over $50 million - so the Bill Gateses of the world are NOT included in this figure.)
It gets even worse when you look at tech stocks alone. Kevin Schwenger, the insider data research analyst at Thomson Financial, who puts out these numbers, told the story in the Wall Street Journal... In August, $644 dollars of stock were sold for every dollar of stock bought by insiders at semiconductor companies. As a frame of reference, $20 sold for every dollar bought is considered bearish...
Yikes...
While the 'smart money' sells tech stocks in record amounts... the 'dumb money' is taking on debt to buy these stocks on margin. By my studies, the 'dumb money' is at an extreme of optimism not seen since, well, right before the 1987 crash... In the last few months, individual investors have become more bullish than at any time in history (as measured by the American Association of Individual Investors sentiment poll), except in 1987.
And the same is true of newsletter writers. The folks who write investment advisory letters (like me), as a group, are now as bullish as they've been since 1987 (as measured by Investor's Intelligence, who has been monitoring these things since the 1960s).
When optimism reaches extremes, as it has right now, quite frankly, there is nobody left to buy... Individual investors have been buying... newsletter writers and analysts have been buying... and the pros have been buying. There is no 'greater fool' left to buy and hope for a higher price. There is nobody left to buy.
We're extremely close to the scariest scenario imaginable, at least from my perspective.
There are three major ways to size up the markets to get some clues on where it might be headed: fundamental analysis, technical analysis, and analyzing the market sentiment. All three reveal a gruesome spectacle.
We've already made the case about market sentiment - the dumb money is at a record level of optimism, while the smart money is at a record of pessimism. Which crowd do you want to be with?
In the case of fundamentals, stocks are still more expensive than they've been at any time in history. We are still at 30 times earnings and three times book value in the case of the S&P 500 Index of the big, boring stocks. And of the tech stocks, oh my... by my calculation, the companies of the Nasdaq 100 are trading at a price-to- earnings ratio of 49. To explain this in plain English, if you were buying a stock with a P/E ratio of 49 as a business, it would take you 49 years to break even on your investment. Why would anybody in their right mind borrow money to invest in that?
The Nasdaq 100 Index is trading at 8 times sales. If you were buying this business, that means if you paid yourself every penny of sales for the next eight years, you'd break even. Of course, you can't pay yourself every penny of sales. Rent needs to be paid, salaries need to be paid, and of course it will cost you money to make your product. In other words, getting your money back in eight years is a total pipe dream. The basic point is, fundamentals in tech stocks are horrific.
All that's left is the technical analysis - the major trend. The trend has not broken down yet... but in the face of horrific fundamentals in the tech-heavy Nasdaq 100, and the truly scary insider selling in the tech stocks, it is time for us to place our chips on the table that the Nasdaq 100 will be lower a year from now than it is today.
When the market breaks down, you can't say you weren't warned...
ASX Price at posting:
0.0¢ Sentiment: None Disclosure: Not Held
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