Fool's Eye View

[ April 17, 2000 ]

Calling the Top?

By Maynard Paton (TMFMayn)

Carburton Street, London -- With the sharp declines on all the major stock markets in recent days, Foolish investors could well be thinking we are entering a bear market. With last week's economic data suggesting the US Goldilocks economy (do you remember that old precursor to the "new" economy?) perhaps suddenly changing into a porridge-eating Grizzly Bear economy, worldwide stock markets could be entering some sort of long-term gloom-laden phase of raging inflation and high interest rates.

Anyway, there are always market soothsayers who come out of the woodwork at these times and say "I told you so!". Indeed, as some sort of market pundit myself, I have been very sceptical of high-tech valuations for some time: have a look at this post, and this one.

The use of price-to-earnings ratios (P/E) and other fundamental tools of traditional investment valuation are just one way to determine whether the stock market is overheated. But rarely will these measurements signal the actual "top of the market". Of course, as everyone knows, sudden rushes of stock market optimism can put to one side the rather tedious investment concepts of intrinsic value and the margin of safety. P/E ratios can tell you that companies are overvalued, but that overvaluation can continue for some time.

So, have we passed the top of the market? Far better than using financial ratios to determine the top, I have always preferred to use more subjective and anecdotal evidence. Here are three recent observations that made me think that certain sectors were going to have a tough time in the months to come.

Unlikely investors making easy money

Anyone who has spent even a small amount of time on the Foolish discussion boards can't have failed to notice the influx of novice investors in recent months. Now, the Fool welcomes all investors, beginners especially. But the fact that most new investors were lured, alongside a lot of more knowledgeable old hands, to cash in on the "dot-com" bull market mania was certainly a very bearish sign. With nothing more than a dart and the Financial Times, inexperienced punters did appear to pick the tech stock winners with ease. And when that happens, you just know stock market turmoil is on the way.

My favourite "unlikely" investor cashing in on the raging mania for Internet companies is our very own Queen Elizabeth II. Surely when the person who represents all that is tradition, old fashion and obsolescence unleashes the shackles of the past and starts to punt on AIM-listed Internet stocks, then you know the dot-com fury has run its course.

From the Foolish Market News, 7th April 2000:

"Getmapping.com (LSE: GMP) received a boost last November when it asked the Queen whether she could patronise the project. Sure enough, Her Majesty agreed and sent back £100,000. The company decided to take £50,000 of this as a loan and gave the Queen £50,000 worth of shares as well. This royal seal of approval seems to have worked. By the close of play today getmapping.com's shares had risen 25p to close at 225p. That means the Queen is sitting on almost a twenty-fold return already!"

The Sure Thing

Two months ago today I wrote about the interactive investor international (LSE: IIN) flotation, and how it led to an apparent "certainty" of making money in the stock market. Back then, it was considered every investor's right to jump onto the Internet IPO bandwagon and make a couple of quid.

In that iii feature, I wrote:

"But Foolish investors need their wits about them in these heady days of the Internet IPO frenzy. Following the herd into an investment has never been a recipe for long-term financial success. What's required is thinking. And never has the investment brain been more of a requirement when considering which, if any, of the upcoming Internet flotations should be contemplated... As opposed to the apparently risk-free flotation gains, holding expensive rubbish when sentiment turns against you leads to the only true certainty in investment. The certainty of losing money."

The stock market rarely gives away free and easy money. When it does, the questions to ask is not "How much more can I make?", but instead should be "How much longer can this really last for?". Again, just like the "unlikely" investor making a killing, easy stock market riches usually equal imminent market danger.

The Last Bear turns (or resigns)

Another classic sign is when the last bear throws in the towel and reluctantly accepts that the stock market is really in a new economy or paradigm, and that traditional investment measures are to be consigned to the dustbin. For when the last bear turns, he or she then becomes the theoretical last buyer of shares. From then on, without buyers, share prices have only one way to go. So, it was quite scary for me to hear of the notorious stock market bear Tony Dye relieving himself of his duties at fund manager Phillips & Drew in March.

None of these events on their own are true "top of the market" indicators. But the fact that the three quite bearish signals occurred together in the last two months did lead me to believe that trouble would eventually arise in some overblown investment sectors.

Of course the question now is whether the recent investment turmoil will continue or whether is was all a flash in the pan. My own opinion is that the rout of the technology sector still has some way to go. But then again, nobody really knows. If the stock market declines do continue, I for one will be looking out for some anecdotal signs that should indicate that value is at hand.

Certainly, if I read about new investors being scared to invest in equities by the general stock market depression, if I read about investors totally ignoring flotations because of the perceived speculative nature of that type of investment, and most tellingly, when I read about large swathes of technology bulls finally handing in their investment chips declaring "The Internet just isn't the future", I'll know it's time to start being bullish.

Please pass your comments to the Fool's Eye View discussion board.

Related Links

• Death, taxes and the iii float
• By, bye, Tony Dye
• Fool's Eye View discussion board