Stock markets at home and abroad seem to be faced with an unusually high degree of uncertainty as we race towards the end of the first year of the new millennium.
At home the latest inflation figures pointed to a peak in the Irish inflation rate of over 7 per cent. Although this rate of consumer price inflation is almost certain to decline next year, the Irish inflation rate is likely to remain well above the European average for several years. Not surprisingly industrial unrest is growing as the unions demand compensation for this erosion in living standards.
On the international stage the euro continues to trade uncertainly. The European Central Bank seems to have finally got off the fence and has engaged in several unilateral interventions to support the currency and this seems to have stabilised the euro around 0.85 to the dollar. However, the foreign exchange markets remain unconvinced that intervention will ultimately be successful in stemming the euro's decline.
In addition to the economic and financial uncertainty, markets are also having to cope with the stalemate in the US presidential election. The US political system has been plunged into uncharted territory and this is having a negative impact on investor confidence.
This phase of political uncertainty has coincided with a period of high volatility in share prices, particularly in the US stock markets. Over the course of the previous week the Nasdaq Composite index declined by more than 12 per cent, while the more broadly-based S&P 500 fell by more than 4 per cent.
While the uncertain political background is undoubtedly partly to blame for this share price weakness, the slowing down in consumer and business demand for personal computers and software products seems to be the biggest underlying negative factor. The most recent bout of weakness in technology stocks was precipitated by statements from Dell and Intel regarding an expected slowdown in demand for their products next year.
In fact Dell produced third-quarter profits that were in line with market expectations. However, the company stated that it expected revenue growth to slow down to a 20 per cent rate in 2001. The share price fell sharply on this news and is now 60 per cent below its year high. For many investors Dell's precipitate share price fall must seem like something of an over-reaction.
After all, revenues and profits are still expected to grow at a very healthy 20 per cent annual rate. However, sharp share price falls in response to even modestly disappointing results have been a feature of technology stocks worldwide since the peak in sector share prices earlier this year.
The accompanying table highlights the extent of these share price falls for a collection of US technology companies. The Intel share price is now trading 50 per cent below the year's peak of $75, while Microsoft is trading at 44 per cent below its peak price.
Also shown in the table is the historic price-earnings ratios (P/ Es) for these companies and this information provides the real clue as to why these shares have proved to be so sensitive to even apparently modest changes in expectations. Even after recent share price declines these companies are trading on historic P/Es ranging from 22-50 compared with the average P/E in the US market of just over 20. To justify these high P/Es companies have to increase revenues and profits at breakneck speed and any faltering in the rate of growth will result in a large percentage decline in a company's share price.
For investors the reality is that high share price volatility is part and parcel of investing in high-growth stocks. Therefore, once the dust settles on both the political and economic fronts, it is likely that investors will return to many of these technology stocks, given that they are still expected to increase their revenues and profits at a much faster rate than the market as a whole.
