Value Library

The following is an excerpt from the ABC Perspective - April 2001 - Pg. 1

Nonsensical Noise

Up until the recent precipitous stock market decline, greedy, neophyte investors felt assured that the stock market was the "proverbial horn of plenty." Common shares, in their view, were a win-win situation since periodic stock market declines had always come roaring back.

As a professional money manager, however, I did not share this view. Like many observers I had become increasingly alarmed at the astronomical market valuations that investors had placed on mere mortal corporations such as Nortel, Amazon, eToys et al. Furthermore, I had become increasingly concerned about the growing nonsensical noise which inexperienced investment commentators had nurtured amongst the gullible public. But little did we know that this placid and prosperous period would ultimately lead to an eventual stock market meltdown.

Now this is not to say that we had called the high-tech/bio-tech bull market 100% correctly. We did not. We underestimated the extent and credibility of the nonsensical noise and the 1999 to early 2000 stock market euphoria. This "bull run" had carried stock prices to unbelievable heights. But given our fundamental value disciplines, even if we had been smart enough to own an assortment of high-tech/ bio-tech stocks, we would have sold out very early in the game due to stretched valuations. In retrospect, I had completely underestimated the power of the nonsensical noise as stocks continued their upward surge. A perfect example was Nortel, which peaked out at 125 times P/E ratio and over 11 times book value; in hindsight Nortel was grossly overvalued.

Clearly for a period of over 12 months the nonsensical noise provided excellent opportunities to take profits and to place the proceeds elsewhere. However it appeared to many investors that this nonsensical noise would continue forever. But much like the Aesop's fable of "The Emperor's New Clothes", when investors eventually stopped to think about the suddenly unexpected profit and revenue warnings and then reviewed earnings per share, P/E's, book value and cash flow, they become concerned. When they decided to sell they discovered there was simply no price support. The rest is history.

What is to be learned from this experience? I believe that nonsensical noise, as irrational as it may be, can become a powerful and yet dangerous stock market driver. During this period anyone can make money in a delirious stock market environment. But eventually the music must stop as greed shifts to reality. In the end it is the rational, inquiring and persevering investor who discovers the ruse of the nonsensical noise and survives to partake in the next market cycle.

Irwin A. Michael, CFA