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Johnson: scared to death
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January 11, 1999: 7:01 p.m. ET
First Albany strategist voices concerns over rising valuations, Internet bubble
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NEW YORK (CNNfn) - As the stock market continues to roar, jumping roughly 5 percent since the beginning of the year, many investors and analysts are wondering, "How long will the party last?"
CNNfn spoke with First Albany's Chief Investment Officer about rising valuations and the growing disjunction between company earnings and share prices.
Here is his "Business Day" interview:
JOHN METAXAS, CNNfn ANCHOR: We were chatting in the break before and you said you've seen a lot of markets, but this one puzzles you.
HUGH JOHNSON, CHIEF INVESTMENT OFFICER, FIRST ALBANY: It puzzles me and it's awfully difficult, because I am very aware, as you are, that we have a lot of good liquidity conditions -- a lot of money flowing into pension funds, into deferred compensation plans, mutual funds -- and that's finding its way to the markets. So liquidity conditions are great, but I've [seen] too much optimism and the market's clearly overvalued.
Not just the Internet stocks, but the large-cap technology stocks are overvalued. So what do I do? I've always said to myself I have never ignored the trend in prices until there's too much optimism and the market is overvalued. And that's where it is now. So what I'm just suggesting is stay tuned, folks, we could have a turning point on our hands very shortly.
METAXAS: Are you preparing your portfolio for that turning point.
JOHNSON: I wish I could say yes and I turn out to be right, but I'm still with the trend. So what I'm doing is a little bit of shuffling in the portfolio. Nothing is really significant.
I'm still, quite frankly, fully invested. I bought a little GE (GE) on weakness; bought a little Microsoft (MSFT). I shifted a little bit of utilities from Northern states power into Bell South, because I want to be in the communications area. So I've made some changes. I'm really changing the furniture, but I'm not changing the portfolio.
METAXAS: You said you bought some Microsoft. Does that go against what you just told me… about the high techs?
JOHNSON: Absolutely goes against it. What I'm doing is I'm still assuming things are just fine. Liquidity is going to continue, but I'm scared to death. I'm still buying those kinds of companies that really did well in the fourth quarter and helped performance, helped my performance which was great in the fourth quarter, and I want to still own those stocks if this thing keeps going.
But I'll be honest with you. When I see this much optimism and this much overvaluation, I'm worried about a turn.
METAXAS: What's the scenario for this turn down? What could spark it?
JOHNSON: You know, I think what would spark it is if reality sets into the Internet. If there was some sort of earnings -- we're in the earnings season.
METAXAS: We're coming up on Amazon.com (AMZN).
JOHNSON: Amazon's earnings, Intel's (INTC) earnings, Microsoft's earnings -- if there are any disappointments along the way, I think that could do it.
This market is so overvalued that it really can't sustain or absorb very easily a disappointment by an Intel. It's not just going to affect Intel - it would probably affect the whole technology sector.
METAXAS: And I misspoke, Amazon doesn't have earnings; we should say the quarterly report.
JOHNSON: Right.
METAXAS: Tom Galvin of Donaldson Lufkin Jenrette is probably one of the more bullish analysts on the street. He's now comparing the market to the 30-year Treasury bond and he's saying the bond itself has a P/E of about 20 when you figure in a 5 percent yield… And if you're paying 20 times earnings for a treasury bond which doesn't have much upside in terms of its price, the market doesn't look overvalued to him. What do you think of that kind of thinking?
JOHNSON: I do the same kind of arithmetic that Tom's doing, and I come up with a different answer - a multiple of 27. I can justify a very high multiple for the S&P 500 based on the decline that we have seen in interest rates and the growth rate of earnings. But I can't justify a 27 multiple, 22, 24, stretching it, yeah. 27, no. So I come up with different answers.
METAXAS: A lot of the rally in the fourth quarter was due to the fact that the Fed has cut rates. Now we see rates backing up. Is this just the backup or is it a trend and what does it mean for the market?
JOHNSON: I think it's just a backup. Because the economy slows - if inflation remains fairly benign, if inflation expectations remain fairly benign, then long-term interest rates, sure, they should back up to a 5.20, 5.30 trading range, roughly, on a 30 year Treasury, but shouldn't go higher than that.
In other words, this is still a pretty good interest environment. But don't look for the kind of declines that we saw in interest rates in the third quarter and the beginning of the fourth quarter. That decline was certainly absurd. And based on obviously that flight to quality. I don't think we'll see that again.
METAXAS: What about some other sectors? Do you think there are safe places in the market? Any sectors that are not overvalued?
JOHNSON: You know, if you are looking for value, in other words if you are looking for stocks that have not really gotten to an emotional extremes, you have to unfortunately go to the small to mid-cap area.
Now, you and I both know that the small and mid-cap area… represents the best value, but investors don't seem to care. In other words, it's not attracting the money flows or the liquidity that's going to drive them higher. So if you're going to go to the value area, you have to be patient.
METAXAS: That's an interesting point. When you say investors won't care. If we have the kind of correction you're expecting, if it goes down 5 percent, won't that be the signal for the money that's looking for some place to go, to go back into the market and buy on the dips?
JOHNSON: We thought that might be the case three or four times, and we've seen corrections in the last four years. We thought that might be the case when we had the correction between July 17th and Oct. 8th of 1998, but it wasn't the case.
When investors came back they came back to the large-cap stocks and they came back to the large-cap stocks because in part, these investors [are investing in index funds].
METAXAS: We're now, what - 10, 11 days into the new year. Already the indices are up 4 - 5 - 6 percent. If you're in the right stocks, you can already be up 10 or 20 percent with your portfolio right now.
Is it time to pack it in and say, "put it in a money market, I've made my gains for the year"?
JOHNSON: The problem is if these things keep going, your performance… will start to lag the market. And your clients are going to look at this, and they're going to say, "I know we were up 4 to 5 percent in the first to 10 days of the year. But the market's now up 20 percent, just like the fourth quarter."
METAXAS: And you're out of the market, and you're only up 4 to 5 percent?
JOHNSON: Our clients would be very upset. So the clients want you to perform roughly in line with the S&P500.
METAXAS: That's pressure on you as a money manager, which is a little different from an individual investor, but nevertheless it's a psychological factor in the market and one would tend to think that that would mean higher prices.
JOHNSON: That's right… and that's a dilemma that the mutual funds are faced with. They're supposed to perform. Their management say, "we want you to perform. We want you to keep up with the S&P 500. But I'm scared stiff. I hate buying… Dell (DELL) or Cisco (CSCO). I have no choice.
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