Stormy Market Weather, and Sun

The Times today continues a new feature, Stock Exchange, in which staff writers James Peltz and Michael Hiltzik debate the prospects for individual stocks and other investments.

Some Words About the Market ...

Jim: Mike, the market’s falling and everybody’s nervous. It’s no fun to see you’re less wealthy each morning when you check the paper at breakfast. So before we get to our stock of the week, let’s go over how investors should handle all this.

Mike: Good idea. There’s an old saying that’s still true, but that people so easily forget: Stocks will fluctuate.

Jim: They’ve forgotten because the market has gone up for years now, to historic levels. But the market will go down, and they’d better get used to it.

Mike: Don’t forget the new element that helps keep everyone confused: the avalanche of market information out there now, much of it contradictory.

Jim: Luckily, we’re not co-conspirators, because we only discuss specific stocks.

Mike: Nice try, Jim. Truth is, every professional market tracker feels compelled to justify his or her pay by citing a “reason” for the market’s performance on any given day. The danger here is that markets very rarely make a one-day move based on that day’s exterior events.

Jim: Worse, there are more “experts” than ever. The other day, I read that there’re now 8,000 Web sites devoted to investing--and that’s just the Internet! And that’s on top of 24-hour television commentators, personal-finance magazines and newspaper gurus.

Mike: I’ll give you an example: We recently had a couple of days in which the market swooned, so every analyst and media outlet was under pressure to explain why. Otherwise, you and I wouldn’t have a story, would we?

Jim: What did we say?

Mike: The reason du jour was concern about Asia’s problems looking worse. But they’ve been horrible for quite a while. Everyone knows how bad things are in Japan. So what’s the new element?

Jim: Well, it’s said more companies are citing Asia for screwing up their profits.

Mike: Come on--that’s been happening for months. The market just went up too high too fast. Asia wasn’t the reason for the day’s action, but the pretext. It’s awfully easy to get the two confused.

Jim: So, you’re saying ignore all the noise.

Mike: I’m saying that to find an explanation for the market’s action, you have to look at things more broadly. By late April, the Dow Jones industrial average had risen about 15% for the year, an annual rate of about 60%. That’s far more than could rationally be justified by corporate profits or any other fundamental. It was waiting for a catalyst to blow off the froth--but that doesn’t mean that one day everyone looked up and got shocked about what was happening in Asia.

Jim: The market’s drop does have one benefit: It forces people to review whether their financial houses are in order. Don’t even think about stocks unless your credit cards are paid off, you have sufficient savings in the bank, and so forth.

Mike: I absolutely agree. It’s a cliche, but the fact is that if you want a 20% return on your money, pay off your 20% interest-bearing credit cards. That’s a better return than you’re likely to get on any stock.

Jim: Also, you know I’m not a big believer in history when it comes to guessing where the stock market might go next. What happened 20 years ago or yesterday might have very little to do with what happens today. But for those investors who might not remember: What we’re seeing now is nothing compared to some other market drops. Listen to this: Between 1972 and 1974, Coca-Cola lost 70% of its value! Yet in just the last decade, Coke has gone up more than 17-fold.

Mike: Let’s not kid anyone: There will be periods when you don’t make any money. Some of those periods have lasted years, in fact.

Jim: Of course. But here’s the point: The optimum time to buy stocks isn’t when everything is peachy on Wall Street. If you wait for that, the train will have passed you by. Rather, the optimum time is when things aren’t going well.

Mike: Assuming you’ve still got your job.

Jim: Right. But remember: This historic bull market in effect began in 1982, when the prime lending rate was around 20% and the U.S. economy was in perhaps the worst recession since the Great Depression.

Mike: Gee, judging from the newspapers lately, I was beginning to think this was our darkest our.

Jim: Exactly! But it isn’t even close. That’s why people have to turn off all the noise buzzing around them.

Mike: The volume of information that’s out there today, even for individuals, is mind-boggling. But most of it cancels itself out because for every bullish prognosticator, there’s a bearish one nearby.

Jim: Investors have to remember that stocks historically have gone up 7% to 10% a year--on average. Yes, the market’s soared 20% to 30% annually for three straight years--but that’s very rare.

Mike: Also, market analysts tend to view the world through the prism of what’s happening at that very moment. In other words, if the market is heading up and you ask, “What’s ahead?” their tendency is to forecast blue skies.

Jim: Some analysis.

Mike: When the market falls 8% to 10%, as it has lately, there’s also a tendency for people to look for the next bear market. But as gamblers know, you can only detect a winning or losing streak in the rear-view mirror.

Jim: Right. In a nutshell, if being in stocks is part of your overall investment strategy, it’s far too early to abandon your plan.

Mike: And if you think that over the next five years U.S. corporate profits will keep improving despite all the world’s ills, then you should be in stocks.

Jim: Which is what we believe.

Mike: We do. And if you’re not comfortable with all of the stocks you’re holding, you should follow a piece of advice that I’ve heard ascribed to J.P. Morgan. The story goes that one of his clients complained, “I own so much stock that I can’t sleep at night.” Morgan replied: “Sell down to the sleeping point, and keep the rest.”

Sun Microsystems

(SUNW)

Sun Microsystems close Monday: $48.63

Jim: OK, Mike, our stock today is Sun Microsystems, one of the big computer stocks on the Nasdaq Market. So, what makes the Sun shine?

Mike: Sun has made a fortune building computers like servers and workstations. These are powerful machines used by big business, government and so forth. But what Sun really is becoming is the leading edge of the anti-Microsoft campaign.

Jim: Meaning?

Mike: Their machines don’t rely on Microsoft Windows software. They rely on a different system called Unix. Sun’s powerful servers use a Unix-based operating system called Solaris. Many experienced techies at big corporations will tell you they prefer Unix to Windows, including Windows NT, which is Microsoft’s answer to these Unix systems, because they’re more reliable when they’re running a large number of networked machines. Then there’s Java.

Jim: Sun wants to buy Starbucks?

Mike: No. Java’s a new programming language that Sun developed. It’s the real darling of the software-development crowd these days.

Jim: They need to get out more.

Mike: Java is easy to learn and it’s very flexible--it can run on any computer operating system--and it’s a good language for moving data over networks like the Internet. And because Sun’s CEO is a brash, often hilarious fellow named Scott McNealy, Java gets its fair share of hype.

Jim: Sounds great. Yet this stock, which trades in the high 40s, has been going nowhere. Last fall it plunged with technology stocks in general, recovered in the winter and then went generally flat. Add it up and you’ve got a stock that’s little changed for the last 12 months.

Mike: Sun’s stock reminds me of one very smart investor we’ve both heard of who’s made a couple of billion dollars. This guy says the one area of the market he won’t touch is technology.

Jim: Who’s that?

Mike: Warren Buffett! The reason is it’s impossible to know where the sandbags are. You’re going to have periods when everybody is switching from one technology to the next, when there are huge shakeouts in sectors of the market, and when there are clouds on the capital-spending horizon. All can be lethal for tech stocks, and I would say we’re smack in one of those periods now.

Jim: So would you buy Sun at this level?

Mike: Yes. Look, it’s a question of long-term theology: Do you think Java is going to beat Windows? Do you think there are enough new platforms out there--hand-held data devices, digital telephones, set-top TV cable boxes--that offer more competition for Microsoft? If you do--and this is the pitch McNealy trots out--then Sun is a long-term buy, because it’s going to be right on top of this with Java. If you don’t, then it’s going to be more road kill.

Jim: I like this stock, too, not only for the reasons you just described ...*.

Mike: You sure it’s not just because McNealy cracks you up?

Jim: He is a very funny guy. But no. Sun is not only going to be a long-term player, it’s running nicely right now. Sun’s fourth quarter ended in June, and its earnings topped expectations despite problems in Asia. Its order backlog is at a record high. It’s keeping a lid on costs. Plus, the stock is trading for only 17 times its expected earnings per share for its next fiscal year. That’s cheap for a big computer player with a future.

Mike: Long-term debt?

Jim: Excellent, almost nil. So you’ve got a debt-free company, a big tech stock with a P/E multiple lower than the S&P; 500’s, and Sun’s talking about growing at least 15% a year. I think the stock can do at least that.

Mike: Sun is a long-term buy, and as much as McNealy sometimes sounds less like a CEO than a game-show host, he’s a smart guy, and I absolutely agree with him that the future of computing lies in making all our appliances into quasi-computers rather than putting all these disparate functions onto the desktop. We won’t be watching video on a computer--we’ll have our eyes glued to a smarter TV. That could be an opportunity for Sun much more than Microsoft.

Jim: But expect Sun’s stock to be volatile and to get hurt whenever tech stocks in general tank.

Mike: That’s right. You have to answer two questions: Do you want to be in techs or not? And if you do, do you want to be in Sun? I say “yes” on both counts.

Jim: Agreed, even if we’re at odds with the two richest men in America--Microsoft’s Bill Gates and that technology killjoy Buffett.

*

Do you have a stock you would like to see discussed in this column? Michael Hiltzik can be reached at michael.hiltzik@latimes.com; James Peltz can be reached at james.peltz@latimes.com. Or write to either at Business Section, Times Mirror Square, Los Angeles, CA 90053.