Reluctant Investor The Shrinking Growth Premium Nov 1 2000 by: David H. Smith

Special From WorldlyInvestor.com So what does a day like yesterday tell us? And how does it set up the final two months of the famous Y2K?

It tells you that the stock markets are wildly rotational, and will probably remain so. After swinging valuations by 10% away from the NASDAQ and the new economy toward the Dow and the old economy, traders decided that was too much and swung the other way. So the pharmaceuticals and consumer stocks that had provided safety during the tech sell-off were put on sale, with big losses for American Home (Symbol: AHP), Schering Plough (Symbol: SGP), and H.J. Heinz (Symbol: HNZ). The giant cyclical rally of the day before showed little follow-through (note for the future: it almost never does).

The technology shares that had been pronounced finished the previous week were stars again for a day particularly the networkers like Cisco (Symbol: CSCO) and the optics stocks such as JDS Uniphase (Symbol: JDSU), Nortel (Symbol: NT), and Ciena (Symbol: CIEN). The argument that one heard was that investors would come back to growth even at a reduced level, rather than sit in a non-grower such as Procter & Gamble (Symbol: PG), which managed to disappoint even its sadly reduced level of expectations.

Theme Market

This is a variation on a theme I used to play here often. "The market values the scarce factor. When growth is scarce, the premium for growth is higher, not lower." The fact that the NASDAQ has shed 25% does not negate this. What has happened is that the growth premium was subjected to a rapid, violent downward adjustment when the level of growth turned out not to be as high as expected. The growth premium is still there; it is just smaller than it would otherwise have been.

So then the question arises, is growth going to be scarce? The evidence now is, I believe, incontrovertible. The third-quarter GDP number that was expected to be 3.5% turned out to be 2.7% instead. Consumer confidence was forecast to have remained firm in October; instead it plummeted. Chicago purchasing managers data fell below pessimistic forecasts to levels that indicate industrial contraction.

For the rest of the week we have a heavy calendar of economic statistics, which I expect to point in the same direction, beginning with vehicle sales, construction spending, and the National Association of Purchasing Management report (NAPM) today.

You have large-scale layoffs at Qwest (Symbol: Q) and DLJ, more to come at Honeywell (Symbol: HON), what amounts to the same thing in dot-com land, and quiet hiring freezes at certain tech- and telecom companies. You have a down stock market, which is no longer supporting a high level of consumption.

Of course confidence is down. It would be miraculous if it were not. That is why we will have a bleak holiday selling season, which looks particularly weak against the strong comparisons of the year-ago figures.

David H. Smith is managing director of Grayling Management, a hedge fund and private investment research and management firm. He has client positions in NT, CMB, CSCO, CIEN and is a former employee of AT&T.

http://www.gomez.com/features/article.cfm?topcat_id=0&col=9&id=6560

-- Martin Thompson (mthom1927@aol.com), November 01, 2000