Believe it or not, the

Nasdaq Composite Index is back in black. For the year 2001, the technology-laden index is up 5.4%, after ending 2000 down 39.3%. Despite a grizzly fourth-quarter earnings season, Nasdaq stocks have surprised the skeptics.


Matt Johnson
Head of Nasdaq Trading, Lehman Brothers

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What's more, many market experts predict the Nasdaq's gain will have staying power. Matt Johnson, head of Nasdaq trading at

Lehman Brothers

, for one, is optimistic about the year ahead, once the economy lifts out of its funk. From his trading desk at Lehman, Johnson talks about why things are only going to get better.

TSC: Is the Nasdaq's recovery for real?

Johnson:

Just as the market overreacted when the Nasdaq approached 5000, it overreacted on the downside, when the index approached 2000. Put it this way: I think we've put in a low for the year. And I think things are going to get better, for two reasons. First, interest rates will continue to go down, if the Fed does what it says it's going to do, which is to move aggressively. Secondly, both the duration and the magnitude of the earnings slowdown is not going to be as great as people think it will be.

TSC: A report released this week by First Call/Thomson Financial stated that earnings growth figures for the Nasdaq 100 in 2001 are downright ugly and that the probability for negative earnings growth for the year is a real risk. How do you feel about that assessment?

Johnson:

Our analysts at Lehman Brothers think the probability of negative earnings growth is less than 50%. The economy is in a slowdown, and the move down on the Nasdaq from 4500 to 2000 reflects a slowdown in the last two quarters of 2000 and the first two quarters of 2001. But I believe we're on our way out of it, at least that is what stocks are predicting right now.

TSC: What is your target for the Nasdaq?

Johnson:

I don't have a specific target, but I think that if the market

Nasdaq returns 10% to 15% this year, it will be an excellent year.

TSC: Can you talk about investor psychology when it comes to technology stocks these days?

Johnson:

It is the antithesis of what it was at the peak of 2000. We've gone from exuberance to fear. But it's a good investment environment when people are fearful.

TSC: Why is that?

Johnson:

People who do their homework and are careful about the way they invest get rewarded. Tough markets distinguish investors who do their work from those who don't. In a market where everything is going up, you buy everything and you don't have to work. In the long run, that's not very healthy.

TSC: What sectors are the Nasdaq's pockets of strength? Which groups are its liabilities?

Johnson:

The pockets of strengths are real companies that produce real earnings. Those companies, for the most part, make up the Nasdaq 100. The 1500-point rally on the Nasdaq in 2000, before the selloff, was from the Internet fluff. A lot of those companies are concepts. They don't have earnings, and a lot of them continually need to go to the capital markets for money to operate. If they don't validate their business models quickly and start to produce earnings, they will be a drag on the Nasdaq.

TSC: Market experts have cautioned against networking and telecommunications stocks, pointing to an industry slowdown. But many of those issues are up for the year. What's driving that, and do you think those groups will stay on top?

Johnson:

If anything is driving those stocks, it is the magnitude of the selloff in those groups in the last quarter of 2000. They are way overdone on the downside and are bouncing. There is a lot of validity to the theory that the world needs more bandwidth and more connectivity to the Internet. That's not a trend. As the world becomes a more homogeneous place, communications and the infrastructure that supports it will become very important.

But there are some fundamental problems that need to be solved, particularly around the purchasers of that equipment. The long-distance business basically funded the build-out for connection to the Internet and I almost believe that the consumer is not paying enough of the bill. Too much competition forced prices down to levels that were unsustainable fundamentally for those companies to operate, and I think they have to come back a little bit.

TSC: In the past, Wall Street has looked to bellwether stocks such as Intel (INTC) - Get Report and Cisco (CSCO) - Get Report to gauge the Nasdaq's performance. Are they still the stocks you're watching? And if so, what do they tell you?

Johnson:

Intel and Cisco, in particular, have certainly proved their business models. They have proven earnings records and they've broadened the amount of products that they offer. Whether or not the old computer platform that supports

Microsoft

(MSFT) - Get Report

Windows is going to be the leader . ... I think the days of that leading are over.

TSC: Who are the Nasdaq's leaders?

Johnson:

Cisco and Intel continue to be leaders.

Oracle

(ORCL) - Get Report

will continue to narrow the leadership spread between itself and Microsoft. But I think Microsoft is a great company.

Sun Microsystems

(SUNW) - Get Report

has proved, through this downturn, that it is a valuable and important part of the technology build-out in the world.

IBM

(IBM) - Get Report

has proved the diversity of its earnings. You've got to look at companies like

Texas Instruments

(TXN) - Get Report

, which has moved into the communications sector, as important leaders.

TSC: There has been so much talk about Cisco's earnings. What do you think its report means?

Johnson:

I think it tells you what everybody already knows: Business was tough in the last quarter. Cisco wasn't immune.

TSC: If the Federal Reserve takes rates down again at its next Federal Open Market Committee meeting on March 20, what do you think the Nasdaq's reaction will be?

Johnson:

A lot can happen between now and then. By the end of March, a little over a month and a half from now, we will have a pretty clear picture as to whether or not we will be moving out of this economic slowdown in the second half of the year. If the Fed takes rates down by a half-point, it tells you that we're going to be in this slowdown a little longer than expected. If they take them down a quarter of a point, it tells you that we're moving out of this thing.

TSC: Is there anything else we should be thinking about for the Nasdaq in 2001?

Johnson:

Decimalization, on March 12. We've seen it affect the amount of volume on the

New York Stock Exchange. It's a structural issue that is going to affect the way stocks trade.

Separately, we should think about the move to an order-driven market from a quote-driven market. The Nasdaq has traditionally been a quote driven market, where dealers quote prices. We're going to get away from that and stocks will by quoted by the orders that drive the process. I think we're three months away from seeing that happen. It's a long overdue move coming from the Nasdaq market itself. Although, these aren't fundamental issues, they certainly affect where stocks trade. And people ought to think about how they affect the way they execute trades.