BUSINESSWEEK ONLINE : DECEMBER 18, 2000 ISSUE
COVER STORY More Bad News for the Naz A comeback could be months away Less than a year ago, the Nasdaq Composite Index was heralded as the new, true benchmark for the stock market. Hedge-fund manager James Cramer proclaimed that money managers who couldn't beat the Nasdaq ''would get the money taken away.'' Investors poured cash into ''cubes''--Nasdaq 100 shares--striving to match last year's 86% gain. The glitzy Nasdaq Marketsite opened on Times Square, sporting a 13,000-foot video screen and ticker. The Dow Jones industrial average and the S&P 500 looked nerdy next to the ''Naz.'' Is it revenge of the nerds? The Dow and S&P 500 are both down only about 8% year to date. But despite the Nasdaq's 274-point spurt on Dec. 5, the highest one-day percentage and point gains ever, so far this year the index is down 31%. Suddenly value investing is hot, growth is not. And even if the Nasdaq, where tech accounts for 70% of the index, continues to gain lost ground, many investors are wondering when and if it will ever stage a sustainable comeback. Short answer: A bottom in the Nasdaq could be near, but it could take months, and some say a couple of years, for a full recovery. The culprits are the ''three E's''--the election, the economy, and earnings. An election result may be near, but the two other E's linger. Despite the possibility of lower interest rates, tech earnings expectations, especially for big companies, are being revised downward in light of a slowing economy. Earnings for the tech sector of the S&P 500 are expected to grow 17% in 2001, according to First Call Corp., the earnings research firm. That's down from an estimated 24% in early October. NOT SUSTAINABLE. According to Ronald Hill, equities strategist at Brown Brothers Harriman & Co., when analysts start revising earnings downward, the period of underperformance is generally halfway through. Since downward revisions in the Nasdaq began in October, and the index began to fall last March, seven months before, the Nasdaq will probably underperform until May, according to Hill's analysis. ''Tech revenues and profits will continue to slow, and it will be difficult for these stocks to be the leaders until you see a real upturn in the economy,'' says Hill. Even now that Federal Reserve Chairman Alan Greenspan has raised prospects of a rate cut--or at least a shift to a ''neutral'' bias--as early as Dec. 19, it's unlikely that tech stocks will suddenly come bounding back. ''It will be 6 to 12 months before lower rates turn into faster earnings growth,'' says Hill. That's because fundamental problems remain in tech: Chip shipments have slowed from 60% growth to 40%, cell-phone sales have dropped 15%, and PC sales have gone from 20% annually to 12%. And next year, telecoms are expected to buy 13% less from equipment makers than they did in 2000. Meanwhile, investors are less willing than ever to pay dearly for erstwhile tech darlings. ''Perception that growth is slowing is really changing investor sentiment regarding price-earnings ratios,'' says Art Russell, senior technology analyst at Edward Jones Co. True, price-earnings ratios have come down dramatically in tech stocks. But have they fallen far enough? The Nasdaq 100 index, which consists of the largest 100 stocks in the Nasdaq, is now trading around 120 times earnings on a trailing 12-month basis. That's well below the 170 times earnings the index traded for when it hit its peak in March. But on a historical basis, that remains high. The average p-e ratio of the Nasdaq over the past five years is 92, according to stock market newsletter InvesTech. There could be more pain in the Nasdaq. Although the index lost an eyepopping 23% in November alone--its worst performance since October, 1987--it still has a ways to go before it gets back to its historical norms. According to a recent study by Salomon Smith Barney, the Nasdaq would have to fall all the way to 2019, some 30% from its current level in order to revert to its 20-year norm of 18% annual gains. Or, put another way, it could simply post no gain at all until September, 2002. ''Five-year annualized gains in excess of 40% just aren't sustainable,'' says Jonathan Lin, a technical analyst at Salomon Smith Barney. But if tech earnings pick up down the road, bigger gains could resume in the Nasdaq. More bad news for investors: This could be a market bubble that takes years to overcome. In the tech bubble of the late '50s and early '60s, computer stocks such as IBM peaked in the fourth quarter of 1961, then plunged. They didn't recover until 1964, says a recent study by Salomon Smith Barney. And oil stocks still haven't returned to the peaks they reached during the oil stock bubble of 1980. ''There's no reason to think this time will be different,'' says A. Marshall Acuff Jr., equities strategist at Salomon Smith Barney. Despite a few brief rallies, the Nasdaq may struggle for a while. But strategists say potential interest-rate cuts ahead could bring the Dow and the S&P 500 back soon. ''There's enough momentum on the upside that S&P and Dow will make new highs in the first half of next year. But not the Nasdaq--there's just too much tech, and it has such a long way to climb back,'' says Brown Brothers' Hill. Looks like the nerds have it. By Marcia Vickers in New York _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP					RELATED ITEMS The Tech Slump COVER IMAGE: The Tech Slump CHART: Tech Spending Slowdown TABLE: Angst in the Air Who May Prosper Despite the Fall TABLE: Recession-Resistant Commentary: Tech Leads--Both Up and Down TABLE: Technology Booms and Busts Commentary: Greenspan: This Is Your Captain Speaking... More Bad News for the Naz CHART: Valuations Remain Sky-High Asian Electronics: Who Pulled the Plug? (int'l edition) CHART: Cooling Down INTERACT E-Mail to Business Week Online

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