Finding Your Way in Uncharted Territory

To figure out how the market is valuing things, use your imagination.
Author:
Publish date:

Are stocks music, and the benchmarks

Beethoven

and

Mozart

? Are stocks sports, and the benchmarks the

'98 Yankees

and the

Chicago Bulls

? Are stocks writing, and the benchmarks

Shakespeare

and

Joyce

? Are stocks war, and the benchmarks the

82 Airborne

and the

Marines' First Division

?

No, stocks are pieces of paper representing shares of companies. They are no more than that. They are linked to the underlying entities that issued them. Occasionally they are linked irrationally to the high side, as in Japan in 1988-89, and occasionally they are linked to the low side, as in September of 1982 in this country, when interest rates were too competitive an asset class, and inflation was not yet licked.

Why bother to state the obvious? Because there are forces and emotions right now that are challenging hard-won assumptions of how to value stocks, and when that happens, we must open our minds to everything imaginable, not to defeat the current method of valuation, but to learn how to use it most effectively.

For that, we must go outside the realm of stocks. To figure out how the market is valuing things, we must go outside the four walls of the stock market, because the emotions of the market are blinding everybody right now. If we simply limit the valuation debate to American price-to-earnings multiples, we know this market is full of baloney already. Heck, if we measure it as a market capitalization game, that is failing too. Price to sales isn't working either. We are in uncharted territory for America.

In fact, if we stick with stock analogies, things get more confused, not less, because the hyperspace we find ourselves in is no different than Japan in the '80s. Ahhh, before you say, well that means we should sell with reckless abandon, are we in Japan in 1984, and are there five years ahead of us to make a huge amount of money? If that's the case, to sell now would be stupid. Are we in Japan in 1988, when there is still a ton of money to be made, but are we late in the game? Are we in Japan in 1989? No, the multiples have to go substantially higher to reach that level. Or does Japan not apply at all, because, unlike Japan, we are not a closed economy pumped by easy money and corrupted by a government-corporate imperative to produce ever higher stock prices (You may disagree with this, but

Greenspan

is enough of a historian to take short rates to 10% if he sees Japan coming. Such an increase in short-rates would make cash too attractive and kill off easy margining. The Japan of 1999 is a living example of what happens if you let your stock market control your economy.)

Remember my goal: to show you how I try to make money without taking on absurd risks. If that wasn't my goal, I would tell you to cash out right now and put it in cash because multiples

are

too high, historically, and the

Amazons

of the world are at this point absurdly valued. That is certainly the easy course. Think about it. You pay us $10 a month, I tell you that we are going to heck in a handbasket. Sell your Amazon. Heck, short it for all I care! Sometime in the next 10 years the market crashes. I say I told you so. That's so easy, that, why, it is positively

Barron's

-like!

But that is not how I am trying to make money, so it would be dishonest and wrong for me to write that!

At times like these, the skill of interpreting the market's moves correctly involves benchmarking away from the language of stocks. Last week I tried an analogy to electricity 100 years ago to explain the Net. (Can you believe the

Journal

ran a piece the next day about electricity and the Internet? Have they no shame?)

Since then I have been struck by a couple of other analogies. In college I took this unbelievable art history course -- Fine Arts 104 -- by Michael Fried, who tried to make us understand how to value and understand modern art.

He started with the usual masters, all of whom I used as my benchmarks for greatness. But then he showed us how

Cezanne

tried to stretch the four walls of the canvas, and then how

Picasso

and

Matisse

took it further, and ultimately how

Stella

and

Ulitski

and

Newman

went to the logical ends of this progression, ultimately leaving the box entirely. At the conclusion, I understood how modern art could be valued the way it is. If I had not taken this course, I swear I would regard all of modern art as a fraud. That means that had I been, say, with

Barnes

, in Europe when he accumulated his priceless collection, I would have completely blown it! So, I ask myself, am I Jim Cramer, pre-Fine Arts 110 dissing

Yahoo!

(YHOO)

at $16, or am I Barnes in Europe spotting

Amazon

(AMZN) - Get Report

at $20 and getting the buy of a lifetime?

Or how about this? I grew up in a house where classical music was the only music worth listening to and classical literature the only stuff worth reading. In our house, no prose or poetry that had been written since 1600 was any good, and no music past

Brahms

was worth a darn. Heck my dad, a violinist, felt that most of the music written this century would hurt the instruments too much to play! Would that mean that if

Paul McCartney

and

John Lennon

had come to me in 1964, I would have dismissed them as unmarketable charlatans? Does that mean that I would have rejected

Steven King's

The Shining

? I don't even want to get into

Spielberg

.

One more: Do I want to be the Germans in 1941, ready with 1,500,000 horses on the border of Russia, about to launch the most disastrous campaign in history? Or do I want to be the United States a completely mechanized army, with dominant air power in 1944?

If you think like this, let's attack things generationally. If you were at the top of your game 50 years ago, you were buying high quality utility stocks. Now many of us are beginning to inherit those portfolios. Are we supposed to keep that stuff or cash it in for something that can deliver our parents' total returns in a day? Are these stocks the cavalry, and we want a

T-34

? Or an

Apache helicopter

?

The reason why we have to keep finding ways to wrestle with the Net in particular and the market in general, is because we can't use the 1939 Prussian cavalry general staff as our benchmark. Nor can we use Shakespeare or Cezanne. We have to deal with what's working and understand the marketplace as it is configured.

Which is why the whole darn thing is so fascinating to me, and why I will spend all year trying to understand what I see -- in a context that helps me make money.

All I can do is explain to you what I see and hope to try to make sense of it myself. And be as honest as I can in explaining it to you

.

Random musings:

It's playoff time and I'm reminded of an important tradeoff: taking something off the table vs. keeping the ball in the air. Around this time I am always reminded that at times the field goal is right. You can only listen to

John Madden

espouse the need to take something from the table so many times to know that not advocating taking some gains can be quite wrong. You can't score a touchdown every time you are on the field.

I write this because in my pieces on new discipline in trading I by no means am implying that selling something is wrong. It is vital that, with these crazy markets, you book something, that you don't just let all of your capital run. Yes, last year, it would have made no sense to ever sell Amazon or Yahoo. But NEVER selling can be a disastrous philosophy. Please don't misinterpret my pieces on new discipline to mean that you should never go for the field goal. You will never make the playoffs that way.

James J. Cramer is manager of a hedge fund and co-chairman of TheStreet.com. At the time of publication, the fund was long Yahoo! and Amazon, although positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Cramer's writings provide insights into the dynamics of money management and are not a solicitation for transactions. While he cannot provide investment advice or recommendations, he invites you to comment on his column by sending a letter to TheStreet.com.