Rally Cry

Wall Street is getting more bullish. Apparently there is light at the end of the tunnel. In the early weeks of December, reports of a bottom in the chip equipment business crossed the wires. The announcement of a bottom sparked another round of price jumps as money managers, starved for technology investment ideas, piled into shares of the biggest industry players.

Knee-jerk reactions in stock prices are not really all that unusual. Stocks in the chip sector have been rallying since the latter weeks of September. The new calls just added a little more gas to the fire.

I read a few of the reports that week, and just about every one stated that this was not a table-pounding buying opportunity. Most comments were aimed at making a call on the industry cycle and not the direction of stock prices. Of course, rallies are always welcome and, when you make a cycle call, you typically have to accompany it with a share price target. In this case, further share price appreciation was primarily based on earnings and revenue projections for 2003. A near-term bottom does not necessarily mean immediate improvement on earnings, but it does mean you can bump up your long-term projections.

There is considerable debate as to whether this recovery will be U- or V-shaped. Some of the money managers that are investing in the stocks are saying the industry always has a V-shaped recovery. To me, this is short-term thinking. Yes, the last two recoveries have been V-shaped, but factors influencing those cycles were much different than the ones we are experiencing today.

I contributed to the annual Economic Forecast feature in this issue (see p. 59). I don't do numbers like most forecasters. I am not in the business of predicting exact growth rates. I follow overall trends in an effort to uncover investment opportunities. In my forecast I mentioned this "seemingly self-perpetuating, always productivity-enhancing, but profitless prosperity." In my humble opinion, the New Economy of the late '90s is no more, fortunate accidents are no more, and in my childish imaginings I can see the outlines of the New New Economy, where (heaven forbid) even hard work and discipline will not provide a guarantee of success, much less the ability to press the "Buy Button" on a Web screen. Somehow, some way, companies are going to have to learn to earn and maintain profits in an environment of super-charged development cycles.

Earlier this year I talked about a rally in the stocks that was based on the extrapolation of good news that developed during a seasonally strong period. I am concerned that this rally will take the stocks to valuations that cannot be supported by fundamentals. Right now the market is being driven by excess liquidity. It will take a turn in the end markets — driven by a stronger economy — to support further rallies in stock prices.

So what is the investment strategy of the day? Part of me says to hang on for the ride, while another part leans toward the exit door. I see the largest stocks in the equipment industry as expensive, while some of the lower-priced issues have more upside potential. The problem with this strategy is that money managers primarily invest in the big names because that is where they can quickly gain the most exposure to the sector. You should have some assets in the larger issues, or you might not participate in the rally. In the INFRASTRUCTURE Model Portfolio I have decided to allocate assets to both small-and large-cap issues. Holding a chunk of cash in the event that this recovery does not pan out as Wall Street expects allows me to sleep at night.