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Posted 2/22/2001
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The Speculator
Don't lose your faith in the tech sector
An entire sector has learned its lesson, yet the beatings go on. Perhaps it's time to remember that innovation has a future and growth still beats value.
By Victor Niederhoffer and Laurel Kenner
I set down in a chair by the window and tried to think of something cheerful, but it warn't no use.
-- Mark Twain, Huckleberry Finn
There's nothing more discouraging than losing a gain -- in life or in markets -- when victory seemed assured.
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At its high during the day on Feb. 15, the Nasdaq 100 futures index, which is the Speculator's preferred market benchmark, was at 2,438 -- within 11% of its high for the year. And then Nortel Networks (NT, news, msgs) struck, shocking the market by unexpectedly cutting profit and revenue forecasts. Total demoralization ensued. By Tuesday, the Nasdaq 100 index contract not only was down 10% for the year, it closed at 2,130, a mere 276 points away from where it began 1999.
Only Mark Twain could describe the despondency that Nortel's announcement caused:
I felt so lonesome I most wished I was dead. The stars were shining, and the leaves rustled in the woods ever so mournful; and I heard an owl, away off, who-whooing about somebody that was dead, and a whippowill and a dog crying about somebody that was going to die; and the wind was trying to whisper something to me, and I couldn't make out what it was, and so it made the cold shivers run over me.
Even the truest believers and most astute bulls are saying that the technology party as we knew it in the ‘90s is over. "We're in a severe bear market," writes the libertarian actuary Dick Sears, whose Web site tracks the progress of guru George Gilder's technology picks. The Gilder index is down 61% from its high last year.
Sears sees a villain behind the collapse. "Just at the potentially economy-shattering moment when people began to doubt whether the broadband Internet would ever happen, the Fed decided to fight inflation." Lower rates might have given the dot-coms time to develop business models; instead, "Dr. Greenspan turned into Dr. Kevorkian."
Dave Ciocca, a hedge fund manager in old-hearted Rochester, adds: "Greenspan is becoming like a James Baker for the new millennium. Any time he speaks, no matter what the topic, the stock market goes down."
The trouble with tech
Consider the jeremiad leveled by Richard Wallace in EE Times. "Silicon Valley and the U.S. high-technology industry these days remind me of Detroit in the mid-1970s. The industry has become fat, lazy and stupid," wrote Wallace, director of the EDTN network and a 25-year industry watcher. "The culture created by (William) Hewlett and Dave Packard has shifted from creating great technology and a good place to work to one of unbridled greed and indifference to innovation."
While we can well understand the discouragement from those of a technology bent who are experts in the field, we received a missive that we never expected from Vic's business partner of 32 years, Dan Grossman.
"I find the Nortel lesson very discouraging," wrote Dan, who has been involved with many old- and young-hearted companies both as general counsel and chief bottle washer, beginning in 1960. "If the widely followed, acknowledged leader in optical networking, with significant insider buying, already down by 66% from $270 billion market cap to $90 billion, and having recently warned and reduced its earnings estimate, can turn out to be so incredibly off on its projected earnings and fall a further 33% in one day, how can one rationally buy tech stocks at high multiples?"
Our natural reaction to this tolling of the "tech is dead" bell is skepticism, even when, as in this case, the expertise and track records of those pulling the bell is far superior to our own. In fact, when despondency is so rampant in the markets -- from the drivers of technology even to taxi drivers -- we think a drive may be in order to at least have a look at Wall Street.
Technology fuels growth
Technology has been the major source of growth for individual companies and our economy for the last 150 years. The linchpin of much of this growth has been the development of general-purpose technologies -- drastic innovations that affect a wide range of the costs and techniques of a wide swath of business: railroads, electricity, cars, factories, plastics, lasers, semiconductors, the Internet and genetic engineering.
Note that the last three general-purpose technologies are still in an early stage of diffusion through the economy. We see no reason to believe that the growth from technologies in the future will not exceed that of the past.
Tech did crash in 1973, the decline most similar to ours in recent memory. But technology didn't die in those dismal times, although many tech stocks did. Another day brought many more new companies, even greater innovations and even better returns for investors. Of course, the roster of stocks is quite different today from the Xeroxes (XRX, news, msgs), Polaroids (PRD, news, msgs) and Kodaks (EK, news, msgs) that were the stars 40 years ago.
The lesson is that nothing stays the same. No clearer demonstration than the changeable nature of the technology stars is the admirable book "High Tech Investing" by Roger Bridwell, founder and seller of two successful high-tech investment companies. The book, published in 1983, was a classic of its day. Its goal, "finding the next Xerox" and "discovering a wondrous new high technology stock whose price will soar," is the stuff that is much easier to realize from the armchair than the forecasting chair. Many companies besides Xerox that are listed in the Bridwell book as sure tech bets for the future have also seen hard times or landed belly up.
Growth still beats value
Over time, though, the numbers show that growth beats value. Growth companies are those with earnings growing faster than the market as a whole.
The 1,000 companies in the Russell 1000 Index are divided each year into two groups, value and growth. The criterion is price-to-book value, as well as a consensus estimate of earnings growth, with some overlap between the two groups. From year-end 1978 to year-end 2000, $100 invested in the growth stocks comes to $3,046, vs. $2,206 for the value stocks. (The above numbers on return include dividend yields for both groups. Value stocks yield five times as much, on average, as growth stocks.)
The difference of 38% in favor of growth stocks is in accord with our sense of market life -- the market rewards an investor for investing long term in companies that have high returns on capital. The power of compounding over long periods washes away any divergences in initial price-earnings ratios and dividend yields.
Within the growth-stock arena, it is possible to develop a typology. First there are what used to be called "coffee can companies" or "untouchables" that have great brand franchises, like Procter & Gamble (PG, news, msgs) or Coca-Cola (KO, news, msgs). And then there are the technology companies that owe their success to science and research. For the past year, both have suffered malaise and dishabille.
Tech still leads growth
Between these two growth groups, the technology group is our choice for "most likely to succeed." The long and short behind our vote is that research and science have a staying power and influence far beyond a brand name. Furthermore, the battle of life and the market goes to the young-hearted. It takes courage and knowledge to believe in science, whereas it is all too easy, pleading risk aversion and ignorance, to prefer the consumer staples.
Partial support for our view comes from a comparison of the performance of the Nasdaq Composite ($COMPX), which as we all know from the drubbing that the old-hearted are constantly inflicting, is heavily weighted to technology, vs. the S&P 500 ($INX) itself, which until recently held mainly the kinds of stocks that certain old-hearted investors could understand in toto.
The Nasdaq started Feb. 5, 1971, with a value of 100, and since that time has appreciated 2,218%. The S&P 500 has gained 1,218% during that same period. (Caveat: These numbers, unlike the Russell numbers reported above, are not adjusted for dividends.)
Our own portfolio, consisting mainly of tech stocks, has not been immune to the recent market declines. We last reported its return as of the close on Monday, Feb. 5, when it was up 32%. In our Feb. 8 column, we recommended Edwards Lifesciences (EW, news, msgs), which has since gone up 12%. On average, however, the portfolio has fallen back 8% as of the close of Tuesday, Feb. 20. Still, the total portfolio of 10 companies is now up 21% for the year.
On the theory that it's darkest before the dawn, we suggest augmenting the portfolio by 25% by going on margin to that extent. Same stocks, equal investments.
Of our original five stocks chosen, we have subsequently advised selling three on the grounds that the balance of insider trading had tilted to the sell side. Since then, three others on our current recommended list -- Motorola (MOT, news, msgs), Teradyne (TER, news, msgs) and Xilinx (XLNX, news, msgs) -- also have shifted toward selling. While these sales are doubtless for estate planning and alimony payments only, we would recommend replacing these three with Axcelis Technologies (ACLS, news, msgs) and Techne (TECH, news, msgs).
In a final assessment of what went wrong, the actuary Dick Sears points the guilty finger at the Fed.
"I don't know why the Fed acted so hastily, so like a teenager on his first trip to the back seat with a cheerleader, instead of like a prudent and conservative guardian of the economy," Sears wrote. "One can't dismiss the notion that they were carrying out the wishes of the Old Economy to teach the young whippersnappers a lesson."
Whippersnapper index
We met one of those whippersnappers this weekend. Jose Rodriguez, 44, of the Dominican Republic, drives a taxi while he studies computer programming.
Lore has it that the old-timers knew the market would peak in 1929 when the shoeshine boys started to give stock tips. In our own time, this theory goes, the peak came when the taxi drivers started to trade stocks on their beepers.
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Jose said he had started to invest in tech stocks a year ago, just as the market peaked. "I lost a lot of money," he said. "This month, everything that was left was lost."
He's had enough, at least for now. He says he'll give it another two years before attempting Wall Street again. "I learned a lesson," he said. "If I get a chance to go back, I'm going to have to be a little more cautious."
Jose does not have the luxury of serving as a plumber in Sun Valley, Idaho, a favorite playground of the nation's wealthy. Nor does he enjoy a shoeshine man's access to the elite, as he is just a taxi driver. Nevertheless -- dare we call his sentiments an omen of an upturn?
At the time of publication, Victor Niederhoffer owned the following equities mentioned in the article: Axcelis, Conexant, Motorola, Nortel, Techne and Teradyne. Laurel Kenner owned none of the equities mentioned in the article.
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