‘Net Pits Wall Street, Main Street

One of the stock market’s enduring legends has it that Joseph P. Kennedy, multimillionaire founder of America’s most powerful political dynasty, was saved from the Crash of 1929 by a stock tip from a Wall Street shoeshine boy.

Kennedy, a veteran stock speculator, ignored the tip, of course. But he told himself: If teenaged bootblacks are in this market, then I’m out.

To many investment professionals, today’s version of the shoeshine boy is a 25-year-old with a laptop computer frenetically trading Internet stocks.

Propelled overwhelmingly by small investors buying and selling through maverick online brokerages such as E-Trade Group, the Internet stock boom of the last few months has blindsided the Wall Street establishment like nothing before.

And as with so much else about the burgeoning Internet, what is happening in the stock market ultimately is a power struggle between the old ways and the new.

So far, the mania has seen share prices of Internet-related companies sometimes quadruple in a day and billion-dollar enterprises bloom like tulips. The combined market value of the 20 companies in TheStreet.com’s Internet stock index--including such names as Yahoo, America Online, Netscape and Amazon.com--has more than tripled, to $172 billion, since mid-October. None of these companies existed a decade ago.

America Online, which alone has stock now worth $67 billion, has eclipsed the market value of such industrial giants as Du Pont, Chevron and Eastman Kodak.

At least for the moment it has. Last week, the Internet stock frenzy showed signs of fatigue. Some of the most popular stocks suffered declines of 30% or more, while investors complained loudly of trading glitches that made it difficult to buy or sell shares. Online brokerages said their computer systems were buried under an avalanche of orders. In short, the very popularity of the game was causing it to break down.

For professional Wall Street, a comeuppance for the army of individual Net stock traders couldn’t arrive soon enough. Indeed, the Net stock craze has seemed factory-engineered to drive the brokerage establishment crazy.

Not only do the Internet stocks lack a pedigree--many of the hottest firms have yet to earn a nickel of profit--but the people trading the shares thumb their noses at the investment tenets that Wall Street holds dear.

Net stock investors make a mockery of the concept of “buy and hold,” the pros complain, they can’t read a balance sheet, and many of them don’t know any more about the companies they’re trading than their four-letter stock symbols.

“We don’t like to think that somebody who knows less can make more,” acknowledged Peter Bernstein, author and longtime money manager.

While some of the neophyte traders have indeed made huge profits in recent months as Net stocks have rocketed--Net directory firm Yahoo, for example, has soared from $100 to as high as $445--many veteran Wall Streeters predict that it will all end badly: The Internet bubble inevitably will burst, they say, causing horrifying losses for people dabbling in the stocks.

“It’s disheartening, to say the least,” said Hugh A. Johnson Jr., longtime stock strategist for First Albany Securities. “Brokers sometimes feel like [economist] Roger Babson in 1928 or ’29 warning of the crash. It sounds like sour grapes, and the naysayers are always reviled.”

Some Fear Ripple Effect

Concern extends beyond the Internet stocks themselves. A collapse of those shares could drag the entire stock market down, some experts worry. That, in turn, would batter consumer confidence and threaten the health of the U.S. economy.

Yet many of the small investors happily playing the Net stock game may see more than reasoned caution behind the brokerage establishment’s hand-wringing.

However much lip service may be paid to the individual investors being the bedrock of the U.S. capital-market system, critics say the fact is that Wall Street abhors democracy.

Indeed, the Street’s jargon is rich with terms of derision for the nonprofessional investor.

When stocks rise in the midst of a bear market, it’s a “suckers’ rally”--the suckers, naturally, being small investors lured in ahead of another steep dive in prices. And when shares are said to be moving from “strong hands” to “weak hands,” the implication is that the pros are unloading and the rubes are buying.

Forbes magazine summed up the attitude last week in an article about Internet trading headlined: “Amateur Hour on Wall Street.”

But whatever else can be said about the Internet stock boom, it is hands-down the most democratic market phenomenon of this century. Whether the bubble bursts or keeps inflating, the way stocks are bought and sold has changed forever. And the power of individual investors to write new rules for the market seems only likely to grow.

Previously, if you wanted to join the latest investment rage--be it biotech in the early 1990s, data processing in the late 1960s or radio in the Roaring ‘20s--you went to an oak-paneled brokerage office and opened an account, or funneled your money to a mutual fund manager who made stock decisions on your behalf.

Now you log on to the Internet, click over to an online broker’s Web site, type in your credit card number and start trading individual stocks without guidance, or interference, from a “professional.”

At the end of 1998, there were about 100 online brokerage firms with 6.8 million customer accounts, according to Gomez Advisors, a Concord, Mass., consulting firm.

That total still is dwarfed by the 80 million accounts at conventional brokerages, including 40 million at Merrill Lynch and other full-service firms, 10 million at discounters such as Charles Schwab and millions more at mutual fund firms such as Fidelity Investments and Vanguard Group.

Growth Only With Internet Accounts

But the growth is all on the Internet side. Online accounts totaled just 1.5 million at the end of 1996. Gomez projects 17.5 million by 2002.

“Traditional stock brokerage was always an information arbitrage,” said Julio Gomez, founder and head of the consulting firm.

In other words, the broker knew more than you did and charged you for the difference. If you wanted to know the current price of IBM, its estimated profit this quarter, even how many shares you owned, you had to ask a broker.

Now you can get real-time stock quotes and breaking corporate news online at no cost. You also can get instant updates of your stock portfolio or retirement fund.

With information so easily available to all investors, traditional brokers are being challenged to prove that they can still add value.

“The idea of six-figure incomes for stock brokers--firms that expect that to go on forever may be in for a shock,” Gomez said.

To be sure, the securities industry is hardly the only business that feels threatened by the Internet. As the online population mushrooms, all commerce stands to be affected by this new force.

Full-service brokerage firms insist that a premium will always be paid for their economic analysis, stock-picking acumen and years of experience in good markets and bad.

Josef Block isn’t so sure.

Block, 30, is a customer-trend analyst for Pasadena-based Internet service provider EarthLink Network. Like many of his computer-savvy contemporaries, he now trades Internet stocks via the Internet.

In his best week--two weeks ago--he said he cleared a profit of about $9,000. He hopes one day to make it a full-time occupation.

Block does his own research and, given his day job, feels fully qualified to judge the prospects of Internet companies. At one time or another he has owned most of the hottest Net names, seldom holding the stocks for more than a few days before taking his profits--or, more rarely, losses--and moving on.

Block pays $8 to $13 per transaction through his online brokerage account with Ameritrade, as compared to perhaps $60 a trade through a full-service broker such as Merrill Lynch or PaineWebber.

“I don’t think most brokers can justify their price differential,” Block said.

He also noted that in recent years, most professionally managed mutual funds--an industry that still controls more than $5 trillion in Americans’ savings--have consistently underperformed the return earned by simply owning the biggest blue-chip stocks.

That has spurred more individual investors to manage their own money, on the assumption that their prospects can’t be worse than those of the pros who want hefty fees to do the same.

Online brokerages have grabbed that theme and run with it in a blitz of TV, radio and, yes, Internet ads.

One current ad shows a mansion paid for, the ad implies, with earnings from investments. “Unfortunately,” says the announcer, “it belongs to your broker.”

Still, the sums that online investors wield remain a pittance compared with the trillions controlled by the Wall Street establishment.

But in their own arena, Internet stocks, online investors are a dominant influence.

Plexus Group, a West Los Angeles consulting firm, found that in the two weeks ended Dec. 1, 77% of the trading in shares of online bookseller Amazon.com was in blocks of 1,000 or fewer shares--chunks of stock too small to be attributed to institutional investors, which typically trade many more shares at a time.

Debate Over Stocks’ Values

The amateurs have shown what a lot of little trades can do. In the first six days of trading this year, Amazon.com’s stock price leaped 72%, to $184.63 a share from $107.08. In the process, the firm, which had fourth-quarter sales of $250 million but still lost an estimated $85 million as it invests heavily to build its business, hit a peak of $30 billion in market value, surpassing such blue-chip firms as Texaco and Merrill Lynch.

The debate over how to properly value a promising new company is as old as the stock market. While many Wall Street veterans say small investors have bid Internet-related shares to absurd heights considering that few of the companies have yet shown a profit, many individuals see things differently.

Merle H. Horwitz, a 70-year-old West Los Angeles investor who has been active in Internet stocks, argues that “an entirely new world is developing, and we will clearly have to go through some growing pains . . . but it seems likely that certain Internet companies will flourish and that the stock prices will too.”

Wall Street traditionalists, he contends, “do not have useful data to measure our new world.”

Few pros doubt that, long term, successful Net-related companies will have vast earnings potential. Rather, much of the criticism leveled at the Net stock mania today focuses on the fact that the market seems increasingly dominated not by individuals taking the long-term view, but by an army of small-time speculators addicted to rapid-fire trading.

Block, the Pasadena trader, acknowledged that many online investors have a time horizon “measured in minutes,” although he takes at least a slightly longer view: “I’ve found the best way to make money is to hold stuff overnight.”

The growing volatility in Net-traded stocks is what scares Bernard L. Madoff.

Madoff has nothing against online trading. His firm, Bernard L. Madoff Investment Securities in New York, is one of the biggest “market makers” for Nasdaq-traded stocks, and facilitates trades for many of the online brokerages.

But he has watched nervously as daily price swings in Net stocks have become huge, and as surges in trading volume have led to long delays and even caused some online brokerages to temporarily shut down.

Shares of U-Bid, an online auction firm, bounced between $62.50 and $101.50 last Wednesday, while Broadcast.com, which broadcasts news and music over the Net, traded between $145 and $203--a gulf almost unheard of in market history.

Unable to get trades executed or to even log on to their brokers’ Web sites, frustrated investors were peppering Internet “chat rooms” with invective last week.

One investor attempting to place a 100-share order couldn’t get on his brokerage’s Web site and so tried the firm’s telephone service, he complained in an e-mail message to a chat room at the “Silicon Investor” site.

“While on hold for 18 minutes so far, my stock is up 4 points,” he wrote. “Four grand so I can save $20 in commissions???? ANYONE trading with this broker is NUTS!”

“These people are pathetic!” another investor moaned about his online brokerage.

“Class action suit anyone?” asked a third.

Madoff and other securities industry officials met in New York early last week to discuss ways to reduce such volatility and avoid system jams. But they seem hard-pressed to find a solution.

Even adding computer capacity won’t help what Madoff sees as the ultimate risk when investors herd into a particular stock group: the inability to find enough buyers should the herd decide, for whatever reason, to exit en masse.

When that happens, prices can collapse in a matter of hours.

“I don’t want to hear people whining that they didn’t know this could happen,” Madoff said.

Whether the slide last week in many high-flying Internet stocks is the beginning of a severe downturn remains to be seen. Shares of Yahoo, for example, sank from $414.50 last Monday to $317 by Friday, a 24% drop. The Net stocks have experienced several pullbacks over the last two years, always recovering quickly.

Trend Appears Likely to Grow

Whatever happens with the Net stocks themselves, it seems clear that online trading by individuals will only grow in the years ahead--and with it, the influence of small traders on whatever stocks they find particularly appealing, either as speculations or as true investments.

One anonymous online trader, e-mailing a reporter last week, had this to say about Wall Street’s fear over the explosion of online trading:

“I think many of today’s ‘day traders’ and short-term speculators are more aware of what is going on than the old market pros give them credit for. Many, like myself, use a portion of our disposable income--not our life savings--to play the Internet hot stock game.

“So the worst-case scenario is for most not a personal catastrophe, or even the loss of one’s shirt,” the trader said.

But he added, “It will be interesting to see what happens.”

Thomas S. Mulligan can be reached at thomas.mulligan@latimes.com

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How Investors Value Net Firms

Despite last week’s stock pullback, many young internet-related companies still are valued at levels that exceed the values of many established and profitable companies. A sampling of current market values in billions (stock price multiplied by number of shares outstanding):

Leading Internet firm: America Online: $67.1

Non-Internet-based firm: MediaOne Group: $31.7

Leading Internet firm: Yahoo: $31.3

Non-Internet-based firm: (FDX) Federal Express: $11.7

Leading Internet firm: Amazon.com: $22.2

Non-Internet-based firm: Barnes & Noble: $2.7

Leading Internet firm: Ebay: $9.0

Non-Internet-based firm: Sotheby’s: $1.3

Leading Internet firm:: E-Trade: $4.9

Non-Internet-based firm: Bear Stearns: $4.8

Source: Bloomberg News