The InvestMentor

April 5, 2000

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I had an epiphany in the middle of the night after the Nasdaq swung nearly 700 points on Tuesday. Maybe it was watching panicked investors dump shares to meet margin calls, maybe it was the culmination of my concerns over the last twelve months, maybe it was too much spice in the Kung Pao chicken. At any rate, I woke up the next morning, got some coffee, and cut my weight to technology stocks in half. Then I pounded out the following email to clients. I’m sharing it with you to give you some (spiced up) food for thought.

April 5, 2000

Dear Clients:

I've made a very intentional, tactical maneuver. It's the kind of thing I've only done one other time in the last four years. First let me tell you what I've done, then I'll tell you why I've done it.

I've reduced our exposure to the high technology market, by almost half. Specifically, I sold half of the position in eight of our stocks--the most volatile, high-flyers. These stocks have done very well for us, but I believe they contain an inordinate amount of risk, that will manifest itself sometime this year. Collectively, these stocks account for about 40% of our equity holdings, thus the liquidation will transform almost 20% of the equity portfolio value into cash (money market funds).

These stocks are...(author’s note: the actual stocks aren’t the point). Note that we didn't sell ALL the shares, of any of them. They're all great companies and we'll continue to benefit from their long-term prospects.

Much of the cash that was raised will go back into the market soon, by way of adding to the other, non-tech parts of the portfolio. Some cash will remain in money market funds until later this spring, summer or even this fall, when it appears that the tech market has stabilized--at which time we'll add to most of the stocks we pared-back.

My reasoning for lowering our exposure, is based on many factors. Ultimately, the decision was driven by an intuitive belief that demanded action--something impossible to explain, and that only comes along once in a blue moon. You might have seen something like this coming, by way of recent writings including my articles on selling Cisco (CSCO), "Expectational Risk," and my piece titled "Tech-aholics Anonymous." Further reasoning includes:

1) RECENT VOLATILITY - I believe that we are on the precipice of a bear market for tech stocks this year. From its peak of about 5100 last month, I believe the NASDAQ could fall below 3000--a 40% drop--or even lower. We're already 17% below the peak. How long this lasts is largely going to be a function of magnitude. The faster the market falls, the shorter the period will be, and the quicker the start of the recovery. I took the opportunity to sell into today's stability, because I think it will be short lived.

2) LIQUIDITY PROBLEMS - The last week of trading is but a small taste of the panic selling that is likely to ensue, presumably sooner, rather than later. Most investors in tech stocks have no exit strategy and will wait until the market's in a free-fall--and then they'll liquidate all of their positions, creating a liquidity pinch. The parts of the market that have done the best recently, will continue to do so for the rest of the year.

3) BUBBLE NEEDS TO DEFLATE - As I've said, ad nauseum, the mania for tech stocks has created a speculative bubble, the kind that comes along every couple of decades, but ultimately ends in a deflation. Most technology stocks are overpriced and while this condition has existed for some time, it's unsustainable. They will all ultimately trade at lower valuations, with less variability, than they do today. Ironically, many of these companies will grow gangbusters, but because investors have overpaid for that growth, prices will move inversely with earnings, until they reconcile at a lower valuation.

Please consider a couple of other points:

I'd rather be wrong than right--literally. I truly hope the tech market, and the broad market, recover from here. Time will only tell as this is a decision based on my forecast for the rest of the year.

This is a "risk-based" decision, not a "return-driven" one. We're foregoing some potential return for a reduction in risk. My reaction to the last two years is one of "appreciation," not "greed." In other words, I accept that we'll may only get 70% - 90% of the upside in the interim, if that means we don't have to take 100% of the downside.

The Nasdaq may do just fine in the short term. At some point, it will even have a strong rally. In fact, it could approach the 5000s again, but I believe that it will have to see 3000, before topping 5100. A strong rally will result in more selling from those folks who believe they've dodged a bullet recently, and are waiting for a little run to lighten up or get rid of their tech holdings.

The only other time I've performed such a maneuver was during the Asian crisis. In October of 1997, I cut our weight to Asian stocks in half, and then repurchased them a year later. In hindsight, it enhanced returns considerably as those stocks bottomed while we were underweighted--and have done very well since regaining full-weight status. I did not sell any full positions back then either--for the same reason I'm not selling any full positions now--the COMPANIES are just dandy, the outlook for their STOCK PRICES, however, are not.

A falling tech market might pull other stocks down in the short-term, but most non-techs will tend to be resilient over the intermediate term. By and large, most of our stocks have done very well recently and we've done better than the NASDAQ in this period. Overall, I'm still optimistic for stocks, and our diversified exposure should bear fruit. In other words, this will be a contained phenomenon.

I will invest new client assets in the weighting scheme, described above: average weights for all but eight stocks; half weight in those eight; and about 16% cash.

Respectfully,

William L. Valentine, CFA

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