Although the Nasdaq finished above its Friday lows and could be bouncing back by the time you read this, last week the panic was palpable.
Mutual funds dumped stock by the carload. Brokers sold out the portfolios of customers who couldn’t meet the demand for more collateral on loans against their holdings. If you could hurt yourself jumping out of one-story buildings, Silicon Valley parking lots would have been littered with the bodies of techies despairing over their vaporized stock options.
Can anyone here spell “crash”? Anyone want to lecture the old fuddy-duddies one more time about how stock prices don’t matter when you buy shares in the technology companies that are changing the world? The stampede shows anyone who’s paying attention how dangerous it is to buy the stock of even very good companies if you pay extraordinarily high prices for them. Not to mention how dangerous it is to pay high prices for companies with high concepts but little else. The idea had gotten abroad in the land that anything having to do with the New Economy was a good investment and all Old Economy companies were doomed. Well, it turns out that lots of New Economy companies have no prospect of profits, now or ever, while large parts of the Old Economy–auto, steel and chemical makers, among others–are moving business to Web sites at warp speed. Darwin would be pleased.
Given that the Nasdaq tanked every day last week and the contagion spread to the Dow on Wednesday, the only Wall Street product that’s showing gains lately is hot air. By now, you’ve probably been inundated with news, commentary and just plain babble about this Maalox Market. All you want to do is clutch your stomach, but people keep banging you over the head with historical parallels to “prove” that it’s time to buy. Or sell. Or sit tight. Or offer human sacrifices to Mammon, the god of Wall Street. The one question you really care about–do you sell out, do you stay put, do you buy?–is the one that no one can answer.
Another question no one can answer is, “Is it Over?” Are the good times going away? For five years the market has made so much money for so many people that it’s become economic crack cocaine. Trillions of dollars of stock-created wealth have increased consumer and business spending, produced enough windfall tax revenues to send the federal budget (and many state budgets) into surplus, have financed much of the cost of rewiring America for the Internet. Scads of companies now use the stock market to help pay employees, giving them lavish stock options instead of lavish paychecks. If stocks go down and stay down for, say, a year, getting off our national stock high will be like an addict trying to go cold turkey. The virtuous cycle of rising stock prices that made everything better than expected can turn into the vicious cycle of lower stock prices making everything worse than expected.
So what went wrong? You can probably date the swoon’s start to April 3, when Judge Thomas Penfield Jackson issued his ruling in the Microsoft antitrust case. Microsoft promptly fell more than 15 percent, knocking around $80 billion from its stock-market value and starting the Nasdaq implosion. Instead of what you would expect–Microsoft tanking, rival companies’ stocks rising–the contagion spread like a financial computer virus, infecting tech companies everywhere. Since Nasdaq is dominated by tech issues, it took by far the biggest percentage hit. The seemingly irrational reaction to a well-telegraphed event shows how volatile the climate was–and still is, for that matter.
When Nasdaq rose a record 86 percent last year and another 24 percent through March 10, everything was good news. If aliens had destroyed Silicon Valley with lasers, the Nasdaq would have risen on prospects of a rebuilding boom. But the mood has shifted. Everything is bad news: rising profits that aren’t high enough, ambiguous profit “guidance” from Motorola, downbeat comments by mutual-fund manager Mark Mobius, a not-so-terrible inflation report, the typically opaque utterances of Federal Reserve Board chairman Alan Greenspan. Someday, maybe even this week, everything may be good news again. Markets tend to extremes. Especially markets like the Nasdaq, many of whose hottest stocks trade largely on the basis of hopes, dreams, hype and momentum because there is little or nothing in the way of profits or assets for investors to weigh. The markets overreact up, they overreact down.
Microsoft is hoping that terms like “Reno Recession” (as in Attorney General Janet Reno, who brought the antitrust suit) or “Klein Correction” (as in Joel Klein, the head of Reno’s antitrust division) pass into general usage. But the reaction to Microsoft is only an excuse for the market to go where it was going to go. The fact that the Nasdaq has fallen so far so fast shows how vulnerable it was. Had Microsoft news not spooked the market, something else would have.
Despite all the weeping, wailing and lamentations for Nasdaq’s losses–down $2.3 trillion or 34 percent in market value since its peak on March 10–last week’s Nasdaq nuking isn’t exactly the end of the world. Remember last year’s run-up. Nasdaq’s value Friday was about what it was last Thanksgiving. The S&P 500 is down less than 4 percent from its March 10 level, and the Dow is up around 4 percent. Yes, there’s been a lot of paper wealth vaporized–but Nasdaq is up almost 50 percent from its year-end 1998 level.
But things just feel creepy. Many Internet stocks–VA Linux Systems, Internet Capital Group, Infosys, Red Hat–are down 70 or 80 percent from their highs, and are likely to fall further. Palm Inc., one of the hottest initial-public offerings ever, is down 80 percent from its first-day IPO price peak. And yes, you can overpay for even good, profitmaking, quintessential New Economy companies. Take Cisco Systems, which briefly was the most valuable company on the planet. It makes gazillions of dollars providing “plumbing” for the Internet. But Cisco fell 24 percent last week. It still isn’t exactly cheap–it’s selling for well more than 100 times its most recent year’s per-share earnings. In theory, the securities analysts who loved Cisco at its high of $82 per share last month should love it even more at Friday’s $57. After all, it’s the same company, but a lot cheaper now. Chuck Hill, research director at First Call/Thomson, which compiles analysts’ reports, laughs when he’s asked how many analysts have upgraded Cisco since the tech swoon started two weeks ago. The answer: none. “In this market, what we see are downgrades after the fact because the stock has gotten clobbered,” Hill says. “If you liked it 30 percent higher, why are you downgrading it when it’s lower?” The answer to this rhetorical question, of course, is that many (if not most) analysts trim their opinions to reflect what they think the market wants to hear. Not to mention what the company wants to hear when the time comes to select an investment banker.
Many of the scores of fragile, newly public Internet companies, most of which should still be in the venture-capital stage seeking money from sophisticated private investors, make Cisco’s stock look as solid as a Treasury bond. If your firm has no prospect of profits and no tangible assets, all you have is faith and a whole lot of “iffy” numbers with little or nothing to do with profits: page views or “unique monthly visitors” or “stickiness” data about how long you think the average customer stays on your Web site. It’s like Tinkerbell in the Disney version of “Peter Pan”: if everyone claps and believes, Tink is saved. If people stop believing, Tink croaks.
Even real companies like Microsoft rely on market magic. Microsoft employees have made far more in option profits since the company went public in 1986 than they’ve made in salary. Microsoft’s biggest cash outlay isn’t for research or equipment–it’s to buy back its own shares from investors to help offset the dilution caused by issuing option shares to employees. Microsoft’s only consolation is that its 25 percent decline is great compared with much larger drops in dot-com companies that raid its staff, waving options, and compete for new hires. Which brings us to another aspect of Microsoft: Bill Gates’s friendly rivalry with Warren Buffett for the title of America’s richest person. On March 10, when the Nasdaq peaked and Old Economy stocks were in the dumper, Gates’s Microsoft stock was worth $55.3 billion more than Buffett’s stake in Berkshire Hathaway, according to data from Insider Research Services. The spread was about the widest it’s been since Gates surpassed Buffett in Forbes magazine’s list of richest Americans in 1994–in hindsight, a defining moment. But as of Friday, Berkshire’s 40 percent rise in the past five weeks, coupled with Microsoft’s 25 percent fall, had closed the gap to $27.5 billion. Buffett’s five-week gain on Gates: $27.8 billion. Please don’t think I’m touting Berkshire, which is intimately entwined with NEWSWEEK’s parent The Washington Post Company (Among the ties: some Post Company employees, including me, own Berkshire as part of our 401[k] plan.) The point of the Buffett-Gates exercise is to show how volatile the market is. And how even old dogs like Buffett and Berkshire can occasionally bark on Internet time.
It’s far too early to declare that the market has lost its magic. But last week’s Nasdaq nightmare shows how fragile a reed the market is. And how silly it is to assume that the stock market will always go up. Or that the market can cure all ills, such as the projected Social Security shortfalls. As they say on Wall Street–or used to say, before prudence went out of style–don’t fall in love with your stocks. Because, you can be sure, your stocks aren’t in love with you.
