Down and Out in Beverly Hills

City of Angels Invaded by Bears

LOS ANGELES -- The Dow Jones Industrial Average fell 2.4% today to its lowest level since March 4, 1999, while the S&P 500 shed 1.8% and the Nasdaq Composite lost 1.5%. Amid a growing sense our long national nightmare in stocks is far from over, it was appropriate that the general session here at the Milken Institute 2001 Global Conference had a decidedly dour tone.

Panel moderator Donald Straszheim, president of the Milken Institute, sought to inject some levity by breaking out a Pets.com sock puppet-mascot during the discussion of the Internet boom and bust, and -- during a discussion of the California energy crisis -- by giving a coal miner's helmet to Tom Higgins, senior vice president at Southern California Edison.

Those moments of Tish Williamsesque jocularity brought laughter from the overflow crowd in the huge ballroom at the Beverly Hills Hilton Hotel. But many attendees were no doubt laughing to keep from crying at the messages coming from, most notably, Byron Wien, chief investment strategist at Morgan Stanley Dean Witter and Douglas Cliggott, chief investment strategist at J.P. Morgan Chase.

I don't know if it was planned ahead of time, but the tag-team effect of Wien and Cliggott -- aided by Merrill Lynch tech strategist Steven Milunovich -- overwhelmed the few panelists searching for reasons to be optimistic. The basic message from Wien and Cliggott is that we've just come from an incredible 18-year period in which, from 1982 to early 2000, pretty much everything went right for the U.S. economy and financial markets, and that we may now be headed for the corollary.

Cliggott compared the situation with crossing the equator and seeing the water go down the drain in the opposite direction.

Wien led off by declaring that the U.S. economy is in a recession and that he believes it will last nine to 12 months vs. the consensus estimate for a six-month slowdown.

He talked about how the "unwinding" from the massive buildup in capital expenditures, mainly on information technology, will take "longer than people think" and that Wall Street is "just beginning to wake up" to this reality.

Throwing cold water on the main argument of the panel's lone optimist -- Ronald Hill, chief investment strategist at Brown Brothers Harriman -- Wien said Fed easing can't solve the problem because it stems from "a deep-seated overextension of capital spending and debt" accumulation.

After a period of heavy spending on capital equipment, businesses faced with a slowdown in sales and shrinking margins are being forced to make "hard decisions" -- namely layoffs. That leads to higher unemployment -- of at least 5% before the cycle ends -- which leads to falling consumer confidence, which leads to more layoffs, Wien said.

Cliggott described it as the "wrong side of the spiral."

As Jim Cramer noted in RealMoney.com's Columnist Conversation, Wien has recently suggested stocks are undervalued, and he did say today there are still values in Old Economy stocks. But his overriding message was that investors need to ratchet expectations still lower. Even though the Comp has lost more than 50% from its peak and that -- after today -- more than $5 trillion of market cap in the Wilshire 5000 has been eradicated in the past year, and investors are crying "Haven't we suffered enough?" Wien said "enough isn't enough" just yet.

Cliggott was even more bearish, suggesting the Dow could be flat for seven to eight years, that U.S. GDP could max out at 2% for the next five years, and that international equities, led by Latin America and Japan, are likely to outperform the U.S. for the next several years. The only thing he seemed optimistic about in the U.S. was energy stocks. He also said big-cap tech leaders could fall an additional 50%.

It was on this point that Merrill's Milunovich added a few zingers to the Wien-Cliggott tandem (which really didn't need any help).

Milunovich, whose ascension to tech strategist last fall was one of the more ill-timed promotions in recent history and who made a rapid transformation from tech bull to bear soon thereafter, first declared the "good news": that technology "waves" generally last 15 years and usually result in a 10-fold increase in the sector's valuation. The "bad news" is that he believes we're currently in a "wave transition" similar to that in the early 1980s, when the era's tech leaders such as Honeywell (HON Quote) and IBM (IBM Quote) suffered greatly.

As was the case in the transition of the early 1980s, Milunovich said the "greatest risk" today is in "the companies with the biggest revenues."

The overall tech sector's price-to-earnings ratio is still around 35 times and above its historic range, and the same goes for other metrics such as P/E to growth and P/E to sales, he said. "It's painful, but there's more downside. The leaders today are unlikely to be [leaders] going forward. Intel (INTC Quote) is a very risky stock for the next five years."

Not surprisingly, Cliggott agreed with that assessment, adding, "I don't know the right level to buy the Nasdaq 100, but I know it's a lot, lot lower" than today's levels.

P.S.

Milunovich's mention of P/E-to-sales led to a discussion in which Straszheim expressed near disgust at the so-called new era metrics that were -- until relatively recently -- used to justify buying stocks without earnings or those already trading at extremely high P/Es.

He was particularly aghast at the use of PEG ratios, noting that in the "old days" if a company's P/E was higher than its growth rate, that meant you should sell, and if the P/E was below growth that meant an opportunity to buy. He suggested investors should and will start going back to that rule of thumb.

And he prefaced that by saying how much he believes in technology and its ability to change/improve the economy.

Not much room to editorialize tonight, nor the time/space to include a comparison of the panelists' current statements vs. their recent track records. Being on location, I'm just trying to do the mood thing -- which as you may have gathered wasn't terribly uplifting.