Despite Scorn, Netscape Orgy Signals Rally in Small Stocks
Don’t pay attention to the messenger. Pay attention to the message.
When Internet software firm Netscape Communications sold stock for the first time last week, the frenzied reception for the shares immediately triggered end-of-era predictions on Wall Street.
Any time the public bids a fledgling stock from $28 to nearly $75 on its first day of trading, speculation must be rife and the death of the bull market must be nigh, stocks’ would-be morticians declared.
But is that really the message embodied in Netscape’s wild debut? Probably not, many market pros argue.
If Netscape signals anything, some Wall Streeters say, it’s that smaller stocks in general are back in demand after being overshadowed by blue chips for most of the past 18 months.
And while many market bears contend that a surge in smaller stocks is itself a classic sign of a market top, history says that isn’t necessarily the case. Once under way, bull runs in smaller stocks can go on for quite a while. The last such run lasted from the end of 1990 through 1993.
Why downplay the significance of Netscape’s frothy arrival? With an estimated 7 million people using Netscape to navigate the Internet, the only surprise would have been if the company’s 5 million shares had not zoomed when they came to market.
Thanks to the communications revolution that Netscape has helped foster, well-heeled computer nerds and non-nerds alike could easily discuss the offering--on-line--for weeks before the deal. Small wonder that Netscape’s underwriters were said to be swamped with orders for 100 million shares.
Obviously, some of the investors who bought the stock after it hit the market last Wednesday feel foolish now. Some paid as much as $74.75 in the first hour of trading, only to see the price slump to $58.25 by the close. (That should teach people to avoid placing “market” orders for highly speculative stocks, meaning their broker is authorized to buy at whatever price can be gotten, no matter how high.)
By Friday, Netscape was down to $52. Still, its 108% first-day gain ranked as the fourth-biggest in modern new-issue history, according to Securities Data Co.
If Netscape’s reception says something negative about the stock market as a whole, then the three stocks that top it on the all-time big gainers’ list also should have been warning flags.
Restaurant chain Boston Chicken, the No. 1 first-day gainer--it soared 143% when it went public on Nov. 8, 1993--arguably was a harbinger of trouble: It came three months before the Federal Reserve Board began raising interest rates, sparking last year’s relatively modest market slide.
But Home Shopping Network, the No. 2 first-day gainer (up 137%), hit the market on May 13, 1986--a full 15 months before the August, 1987, stock market peak.
And the only message in the debut of software maker Tivoli Systems, No. 3 on the list with its rise of 120% on March 10 of this year, was that technology stocks in general were going a lot higher, which they have.
Wall Street’s Netscape-inspired bears might have a more substantial case if they could show that the new-issues market overall is overheating. However, the numbers don’t support that idea.
Since June 30, 77 new issues have come to market, raising $3.66 billion, according to Securities Data. Even if that heady pace is sustained for the rest of the year, the dollar value of new issues in the second half of ’95 will reach $15.9 billion--much less than what was raised in most half-year periods since the second half of 1991.
The peak period so far for new issues was the second half of 1993, when $30.6 billion was raised.
Michael Burke, a veteran analyst whose New Rochelle, N.Y.-based Investors Intelligence service tracks many market indicators, argues that there’s a more simplistic reason why the riot for Netscape shares doesn’t signal a market peak: Too many people probably think it does.
“Usually when everyone worries about something in the market, it turns out not to matter. It’s once they forget about it that it begins to matter,” says Burke, a market “contrarian” by training.
The real message behind demand for Netscape, Burke says, is that many investors are losing interest in shares of blue-chip multinational companies after their sharp run-up in the first half of this year. Instead, investors are looking to shares of smaller companies that have lagged thus far in 1995.
In fact, many smaller stocks have been lagging since early in 1994, after leading the bull market from 1991 through 1993.
Two stock indexes tell the story:
* The Russell 2,000 index, one of the broadest measures of small-stock performance, gained 43.4% in 1991, 16.5% in 1992 and 17% in 1993, topping in all three years the gains of the blue-chip Standard & Poor’s 500 index, which rose 26.3%, 4.5% and 7.1%, respectively.
* But in 1994, the S&P; took the lead, losing just 1.5% while the Russell fell 3.2%. And through May of this year, the S&P; had soared 16.1% while the Russell was up just 7.9%.
Since May, however, smaller stocks have been gaining ground while the blue chips’ advance has slowed, and in some cases even reversed. The Russell has jumped 10.7% since May 30, while the S&P; is up a mere 4.1%.
Last week, as the very-blue-chip Dow Jones industrial average lost 1.3%, to 4,618.30, the Russell inched up and now is just a hair below its record high.
Burke thinks the message is clear: “I see a low-priced-stock bull market coming,” he says.
What’s more, he says the perception that strong gains in small stocks always portend a peaking market--because smaller issues are more speculative--isn’t accurate. Recent history, in fact, suggests that the time to worry is when small stocks aren’t rising.
The Nasdaq composite index of mostly smaller stocks, for example, foreshadowed the 1990 bear market by topping out in the fall of 1989, whereas the blue-chip Dow continued to rise until July, 1990.
Andrew Addison, a technical market analyst who writes the Addison Report newsletter from Franklin, Mass., also believes that the renewed advance of smaller stocks is a healthy sign for the bull market, not a negative.
Despite the Dow’s stumble from its record 4,736.29 on July 17, “one of the main reasons why I think the market isn’t in any serious trouble is that the [rally] has been broadening to include small- and mid-sized stocks,” Addison says.
The changing fortunes of blue chips and smaller stocks may stem from shifts in the dollar’s value and in economic expectations.
The dollar’s surprising strength since mid-May is threatening to crimp overseas earnings of multinational firms. At the same time, if investors expect the U.S. economy to pick up steam later this year, smaller companies--many of which are largely dependent on the domestic economy--could produce better-than-expected earnings.
Looking at the stock market as a whole, Wall Street’s bulls say it’s simply too early to suggest that the market is vulnerable to anything more than a standard 5% to 10% correction after the huge gains so far this year.
At a bull market top, what you expect to see is a change in the fundamentals, says David Bostian, economist at Herzog, Heine, Geduld Inc. in New York. For now, he says, “the fundamentals are still positive.”
Bond yields may creep up a bit more in the near term, but the general trend in interest rates is still down worldwide, Bostian says. Likewise, the changes being wrought by the Republican Congress are largely bullish, he says. And in the long run, a stronger dollar will bring more foreign money into U.S. stocks and bonds.
As for periodic manias like Netscape--well, it’s good for the bears to have something to worry about, says Alfred Kugel, investment strategist at Stein Roe & Farnham in Chicago. “If it had happened and nobody talked about it, then that would be froth,” he says.
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IPO Frenzy? Not Quite
When software firm Netscape Communications sold stock for the first time last week, the phenomenal reception for the shares suggested there is an unprecedented investor frenzy for inital public offerings in general. In fact, the current pace of activity in the IPO market pales in comparison to recent history. Dollar volume of initial public offerings, in six-month periods and billions of dollars:
‘95: $15.94 (Second half estimate if current pace of stock issuance in maintained)
Source: Securities Data Co.
