Investment Outlook

May 2000 --- No April's Fools

Each year, April arrives with the promise of freshness and hope but often leaves us in confusion. The month of April has historically been associated with bad news: the Titanic sank in 1912; the Oklahoma City bombing in 1995; Littleton, Colorado school shooting last year; and yes, annual filing of income taxes to our government. Perhaps the series of market dips this April weren't as tragic when compared to historical events - unless you were leveraged and long Nasdaq tech stocks.

In retrospect, we look at our battered portfolio and wish we had sold our NextBigThing.com at the high. We all knew that after three consecutive months of rapid advances in the equity markets, a correction was bound to take place - and it finally did! Amateur investors lured into do-it-yourself investing learned the lesson the hard way - it is not easy to make quick bucks. Even veteran Wall Street money managers who make bad calls lost and they have billions of dollars at their disposal as well as the best resources. We refer, of course, to the Tiger and Quantum Funds. A string of events triggering the sell-offs started with a cautionary warning by Wall Street's most influential strategist, Abbey Joseph Cohen to reduce equity holdings by 5%, followed by Microsoft's losing the anti-trust trial, and Microstrategy's restatement of prior year financial results.

Looking ahead, does it mean the bull run is coming to an end? The opinion is divided among the pessimists and the pundits. The pessimists insist that the party is over as evidenced by recent weaknesses in the markets, especially the badly beaten tech stocks that are unable to rebound. They say the technology bear of 2000 is signalled by sell-offs in overvalued stocks and worries over inflation. While it is true that investors are no longer fooled by sky-high valuations of some tech stocks, we are of the opinion that the general market weakness we've seen does not necessarily imply a bear market, merely a slow down in the bull run. Signs of a bear market would include very low levels of investment activity across all markets and lack of investor confidence. This is certainly not the case yet, as funds are still flowing around from the new to old economy stocks (and vice versa) as investors once again place confidence in the brick and mortar companies.

The Microstrategy fiasco is probably the landmark case and turning point for high-flying tech stocks to fall back to Earth. No doubt over the next few months, there will be more companies ending up like Microstrategy. Blindfolded investors once lured into net stocks by their false promise to generate such revenue will sure be wary of revenue outlooks. The move by the U.S. SEC to closely monitor the accounting policies chosen by the accounting profession for their high-tech clients will screen out those over-hyped, over-valued companies. Thanks to the SEC, Cloud-9 investors can finally see through the thick smog hovering over those dubious net stocks, which are nothing more than hot-air balloons.

Suddenly, people are beginning to pay attention to the fundamentals and business strategy - not to rely solely on a sexy technical chart or positive momentum. Management experience and depth are discovered as important keys to success, or survival, for struggling start-ups. Companies lacking any of these ingredients are built on shaky foundations unable to survive any economic shock waves. In addition, a late-comer to a lucrative market characterized by intense competition will most likely be squeezed in their margins.

There are countless numbers of failing operations across the spectrum of Internet-related industries: B2B, B2C, e-tailers, dot.coms…etc. Many of these outfits will not be around until the end of the year if they are unable to secure additional funding. Take for example drkoop.com Inc., an online health company that failed in its struggle to compete in the crowded health information Web sector. Wall Street is largely unenthusiastic about such companies, which are seen as content providers with limited revenue growth opportunities compared with firms that are more focused on e-commerce. Facing mounting losses and dwindling cash reserves, drkoop.com Inc. may not continue as a going concern, according to the firm's auditors. Its stock doubled a month after its IPO price and has since plunged to around $2 before trading was halted. What's the future for this outfit? Either declare bankruptcy or be bought out.

Many Internet-related companies will end up in the stock market dumpsite as did drkoop.com. These may include some e-tailers: CDNow, the online music retailer; Peapod, the online grocery store; Etoys, the online toystore are presently on the suspect list. How can these companies compete in a crowded market with established market leaders such as Amazon.com - who still has yet to bring in any profits? How can they expect to be profitable when their selling expenses far exceed revenue?

Expect to see some consolidation between ailing dot.coms with old economy companies and more unfavourable auditor's reports and possibly bankruptcies in the next few months. Most of these operations have gone downhill from their IPO days. Very often, IPO investors don't do much homework on the company before getting in because they believe they can flip it for quick profits. The junk bond market, however, closely scrutinizes the fundamentals and financials of a company and has no appetite for over-hyped deals. The junk bond market is a better gauge of valuation of a company. The scale back of 360networks' recent IPO in the junk bond market conveyed a clear message that market conditions made it difficult to raise money.

Having said that, it doesn't mean you should immediately unload all your new economy stocks, rather take caution to select good investments on the basis of a sensible business plan, good management team, ability to become profitable in a year or two, and operating in a fertile market.

Technology will no doubt continue to be the backbone of our economy and investing in technology is still promising for the long run; but if you prefer less risk, stick with infrastructure. Non-"dot.coms" have real profits, proven track records and a captured market. Infrastructure companies provide and service the platforms, data corridors and networks on which the Internet is built. The most attractive areas are those that stand to benefit from the latest development in the Internet; wireless Web and B2B e-commerce, and those that target a potentially large market with some kind of proprietary competitive advantage. Telecommunications equipment and service providers, software companies and chip equipment makers will stand out as winners in the long haul. Look for intellectual property, smart business models, and an identified position in its market. To name a few non-net players that will be trend-setters: JDS Uniphase (JDSU) supplies key products for fiber-optic networks; Applied Materials (AMAT) makes machines that produces semiconductors; Oracle Corp. (ORCL) sells data bases; Nokia (NOK) and Ericsson (ERICY) make mobile phones that will capture the explosive growth of wireless applications. But be warned, there is an old saying, "bet on the jockey, not the horse" - even great technology could flounder under inept management.