The Big Picture

« Microsoft is in crisis? | Main | Media Appearance: Kudlow & Company (6/20/06) »

Old Stars Don’t Lead New Bulls

Tuesday, June 20, 2006 | 02:12 PM

One of the most common errors investors make is going back to their list of old favorites: These typically include the former superstars of the last bull market. Prior luminaries include Microsoft, EMC, Dell, Intel, Cisco, eBay, etc.

It’s a function of their comfort levels, a bit of rosy nostalgia for the good old days when everything you bought went up, and money was falling from the sky like raindrops.

It has long been a general rule of markets that new bulls require new leadership. Numerous reasons for this exist, but three stand out in particular:

-Prior leaders fastest growth phase are behind them.
New technologies, products and markets came online; By the time the next Bull market started – usually after a few years of a bear market – those industries and products became mature. PCs are a perfect example; They are like dishwashers or refrigerators that get replaced only when they die. The old 286/386/486/586 upgrade cycle has long been consigned to the dust bin of technology history.

-Success invites competition.
Yahoo begat Google, Intel begat AMD, Dow Jones/ NYT Company begat Typepad and Blogger. This is as it always has been and always will. What are the odds that lightning strikes twice at the same firm?

-Excesses of one era set the stage for success stories of the next.
Following the great crash of 2000 (primarily in tech/telecom/internet), the economy flat-lined, leading the Fed to cut interest rates to 46 year lows. Out of those ashes came tremendous activity in Housing and Home Builders, Transportation and Materials, Mortgage Financing and Cash Out Equity Loans – and of course flat panel HDTVs for everyone! These low rates even led to more importing of Chinese goods, which further stimulated their demand for energy and industrial metals. Once this cycle collapses, an entirely different set of leaders are likely to emerge.

The classic example of this phenomenon is the red hot tech stocks of the 1960s bull market. Nearly all of them are out of business today. That period saw big conglomerates ramping up (See Gulf & Western, ITT); The surviving tech names like Xerox and Polaroid and Kodak are now shells of their former selves. This happens with every major advance in technology, from railroads to telegraphs to automobiles to TV/radio to electronics to PCs to . . .

There were many parallels between the late 1990s and the 1960s – at least from a broad technical view. The overall advance in the 1960s got increasingly narrow in its leadership, as investors focused on the Nifty Fifty. In the 1990s, it was the 40 biggest capitalized stocks that were in the mack daddy index of the day, the S&P500. We assume you recall how that ended.

If only it were as easy as simply buying the former fallen stars: Then, everyone would be a stock market genius.

UPDATE June 20, 2006 3:51 pm

Perfect example is Dell, which hit a new 52 week lows today at $23.53.

UPDATE June 21, 2006 5:32 pm

Some people are excited that Dell Chairman Michael Dell, (who presumably knows his business better than anyone else) has been buying Dell shares (down 43%). Dell bought $70 million worth of stock at $23.99. Remarkably, this was his first purchase ever, following steady selling every year since 1988, according to Thomson Financial.

Michael Dell has a net worth of about $13 billion. This "big buy" represented a purchase equivalent less than 1/2of a % of his wealth.

To put this into context of an average person making $100k, owning a home, and a tidy sum of stock in their retirement accounts, its the equivalent of the purchase of 100 shares of Dell stock.

Puh-leeze!