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Around the world, the market prices of many Internet, IT and dot com (‘tech’) stocks have fallen substantially – and not uncommonly by 90% – since the ‘tech wreck’ of April 2000. During October and November 2000 they fell so far and so fast that pundits concluded that ‘tech wreck II’ was upon us; and in February 2001 the tech-heavy Nasdaq registered one of its greatest month-on-month decreases on record. Much more important than these market phenomena are the actual operations of tech companies – many of which continue to ‘burn’ cash at alarming rates. According to analyses published in Australia, Britain, the U.S. and other countries, significant numbers are haemorrhaging to such an extent that they must either find angels, merger partners or disappear by the end of the year.
This cycle of boom and bust can be explained partly in monetary terms (see the circular entitled Interest Rates, Corporate Debt and the Business Cycle). What remains unexplained, however, is the widespread confidence – in some places ebullience and in a few places unabashed conviction – which continues despite the developments of the past year to be placed in technology, the ‘New Economy’ and tech stocks. This circular attempts such an explanation. Part I describes the coalition of confidence and complacency that exists with respect to these issues. Part II sets out the building blocks of a sceptical, contrarian and iconoclastic argument; and Part III derives from these premises a startling conclusion: although there are some individual exceptions, as a whole and as a rule the economic foundations of information, knowledge, It – and thus the New Economy in general and tech companies in particular – are transitory and weak. Moreover, the vast majority of market participants remain substantially or completely oblivious to these fundamental weaknesses. Accordingly, even in the wake of the tech wrecks of 2000, few recognise the grave risks that continue to inhere in the ownership of New Economy securities. Part IV sets out two corollaries, three dangers, a central unlearnt lesson and an ultimate irony which follow from this conclusion.
A Coalition of Confidence and Complacency
If surveys and interpretations of market participants’ expectations are reliable, earnings downgrades and tech wrecks have dented but by no means destroyed faith in the ability of New Economy and tech stocks to enrich their owners. A typical example of this conviction, an article in The Weekend Australian (28-29 October 2000), began with the words “Crash! A dotcom disaster. A sure time to buy if there ever was one. Any veteran market watcher will tell you that when you read those headlines it is time to go bargain hunting. There’s a revolution in technology driving changes in communication and media and now is the time to jump on board, with the caveat of all investment activity: choose wisely.” Another article in the same edition of TWA stated in its penultimate paragraph that “the basic story of internet companies remains as true as ever. They can achieve much faster creation of value than is possible in more mature industries because of their global reach, and because of their ability to transform industries in which information is an important component.”
Coalition Member #1: Market Chroniclers
Not surprisingly (see the links from Leithner Letter 14), many professional market observers, particularly in the U.S., remain ebullient in the face of the earnings downgrades of recent months and the tech wrecks of the past year. Investors Intelligence conducts a weekly poll of about 130 market newsletter writers and calculates the percentages who are bullish, bearish or expect a short-term correction of market prices. During most bull markets the survey averages 45% bulls and 35% bears. In January 2001 II recorded its most bullish reading – 62% – since 1987. During the last week of February bulls comprised 57% and bears just 12%.
Coalition Member #2: Advisors and Institutions
More specifically but no less surprisingly, many professional market participants also remain upbeat about the prospects of tech companies and the prices of their shares. Deutsche BancAlex Brown chief strategist Edward Yardeni [who famously prophesied late in 1999 that ‘Y2K’ would trigger computing glitches, malfunctions, failures and other difficulties sufficiently severe to cause a recession] provides a prominent example. As reported in Barron’s (26 February 2001), Yardeni believes that “we’re clearly in the final capitulation phase” of the collapse of tech stocks’ valuations, that towards the middle of 2001 economic activity and profits will rebound smartly – and that the bear market is nearing its nadir. In his words, “if we’re in for the New Economy’s first recession, blink and you’ll miss it.” Yardeni recommends that holdings of tech stocks remain somewhat underweight until the capitulation fully runs its course. But that time is rapidly drawing nigh. He concludes with the caveat that “even though were letting the last of the hot air from the balloon, one shouldn’t expect the balloon to immediately be patched up and reinflated.”
Other prominent analysts and strategists expressed similar sentiments during the first half of March. The prominent and influential analyst at Goldman Sachs, Abby Joseph Cohen, stated that the savage decline of tech stocks since March 2000 created buying opportunities. Among other things, for the first time in a year she recommended that clients adopt an ‘overweight’ position in the technology sector. When asked on 7 March 2001 about the disparity between her past prophesies about tech stocks on the one hand and the actual course of events on the other, she stated that “everything is simple in hindsight.”
Coalition Member #3: Retail Investors
Whether it is because ‘experts’ have influenced them, central bankers have reassured them or other reasons, retail investors (‘Mums and Dads’ as they are condescendingly known in Australia) remain remarkably composed. In Alan Abelson’s words, “what we find especially striking about this bear market is not so much its concentrated fury as its failure to engender fear and trembling among the investing masses. Even after $4 trillion worth of damage [more than the capitalisation of American equities markets in 1981], the signs of panic are most conspicuous by their absence. Redemptions by mutual-fund shareholders haven’t skyrocketed; even though much reduced, a healthy slug of money is still flowing into equity mutual funds (not Janus, maybe, but, hey, even complacency has its limits); folks aren’t lining up outside Fidelity’s Boston headquarters; there are no widows and orphans decked out in accusatory sandwich signs parading in front of the New York Stock Exchange; and the number of brokers being tarred and feathered is still in single digits” (Barron’s, 5 March 2001).
The Wall Street Journal has documented this phenomenon both anecdotally and systematically. The same small group of tech investors was profiled on 13 March 2000 and 7 March 2001. Despite the pain experienced during the interim they retain their faith in tech shares. One said that “I still feel that we’re just seeing the beginning for technology stocks. I believe that when the dust settles [they] will come back.” Another said that “I still think long-term the market is where you want to be. Six months from now we’ll look back and say there were some real buying opportunities.” According to the WSJ, this “apparently unshakeable belief in technology stocks, even after punishing losses, helps explain why the Nasdaq’s slide over the last year has proceeded in a slow, grinding fashion – a far cry from the panicky sell-off of 1987. But that same sentiment also raises questions about whether a further market drop could trigger a capitulation by individual investors.” Those whom the Journal profiled are sitting tight. The one who lost most in tech shares has no regrets and concludes “I think we’ll get a second chance. I don’t think I was wrong to make the bet I did. We’ll make a comeback. I’m sure.”Coalition Member #4: Central Bankers
Finally, whether professional market participants are influencing them or vice versa, central bankers from Australia to Canada and the U.S. are sending cautious but nonetheless guardedly-optimistic messages about the New Economy and related matters. Indeed, in his February 2001 testimony to Congress Mr Greenspan referred approvingly to a survey of more than a thousand security analysts which showed that their three-to-five-year profit projections were – you guessed it – quite high. James Grant, publisher of Grant’s Interest Rate Observer, irreverently but nonetheless seriously interpreted Mr Greenspan: “when the Federal Reserve is optimistic because brokerage employees are bullish, there must be trouble.”
Bruised and Battered – But Undaunted and Unrepentant
Clearly, then, not just in Australia but also in the U.S. and other countries, proponents of the New Economy are bruised and battered but undaunted and unrepentant. It is true, they realise in retrospect, many tech valuations were unreal; yes, some remain at nosebleed levels and many tech companies will fall by the wayside; and granted, the ride henceforth is likely to remain volatile. But the Internet, IT and dot com revolutions, they continue to maintain, are genuine, all-encompassing and unstoppable. These revolutions are so powerful and unique that – some still insist – they are rewriting the laws of human action. And because they are evolving so rapidly, those people, politicians and nations who just don’t get it (a favourite phrase used by the IT anointed in order to denigrate the benighted) will be left stranded and impoverished in the revolutions’ wake. In their eyes, then, the basic proposition has not changed a single iota: an ‘unreal’ price paid today for the next Microsoft will in the long run be regarded as the bargain of a lifetime.
An even more unpleasant rendezvous with reality, it seems to me, awaits them.
...continued in Part II
 
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