Market Hazing Tests Endurance of the ‘New Economy’
New economy, R.I.P.?
With the stock market in a free fall, and so many once-hot technology stocks now begging for buyers, it will be tempting for some investors to believe that the talk of a new economy was a massive scam.
Unquestionably, the hype got to be ridiculous. It was in the interest of all manner of investment bankers, stock analysts and corporate “dot-com” insiders to fan the flames. After all, they had companies to finance, and therefore merchandise (shares) to sell.
But the new economy, or whatever you’d like to call it, is real--just as real as the new economy that emerged with the Industrial Revolution, or the one that emerged after World War II.
The great promise of the Internet, business-to-business e-commerce, the wireless revolution, digital everything, the deciphering of the human genetic code . . . this market decline doesn’t signify the end of any of that.
What has ended, or at least is on indefinite hiatus, is the excessive speculation about the payoff from the new economy: which companies will get it, and how large the payoff will be for the companies and their shareholders.
Two groups of people engaged in that speculation. One group actually gave some thought to how much money new-economy companies might earn over the next five to 10 years from the demand for new technology, and bought the stocks on that basis.
The other group simply jumped onto the tech-stock bandwagon as it rolled, and in the process dramatically accelerated the stocks’ gains, especially in the first two months of this year. Often, these buyers used borrowed money to make their bets.
There you have the gist of “momentum” investing: Don’t spend time worrying about the fundamentals of the business; if the stock is going up just buy it, on the expectation that it will keep going up.
That’s how shares of so many profitless companies zoomed to levels that only their stock-option-laden executives could feel good about.
With the momentum-investing mind-set now vaporized, people are looking for some new concept to dictate the tech-stock trend. And so the idea of focusing on the fundamentals has returned from Baja, or wherever it was vacationing.
Suddenly, everybody seems to agree that there’s a limit to how high a stock’s price should be relative to underlying earnings.
But what’s the limit? What is cheap, what is reasonable, and what is too expensive when we’re talking about new-economy stocks? Investors will have to collectively make that decision in the weeks ahead.
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Whatever prices may be fair, it looks like we’re going to get there in the Nasdaq market’s usual hurry.
The Nasdaq composite index, dominated by the nation’s major technology stocks, lost 25.3% of its value last week, including Friday’s 9.7% plunge.
The week’s loss was a record, even eclipsing the 19.2% net decline the week of the October, 1987 market crash.
The math is pretty easy now: At 3,321.29 currently, if the Nasdaq index continues to fall 25% a week, in four weeks it will be back to about 1,050--its level of late-1995, long before there was any new-economy talk boosting tech shares.
Would even those tech prices be cheap enough for nerve-racked investors?
Most people won’t accurately guess the bottom, wherever it is for the market overall or for individual stocks. That sounds obvious enough, but it’s worth noting because the view many investors take at a time like this is that it’s better to just wait to buy “when it’s over.”
Inevitably, however, you’ll miss the precise bottom. It makes more sense to start putting a shopping list together of the stocks or mutual funds you’re interested in, establishing prices at which you’d like to buy, and start nibbling if those prices arrive.
What if stocks are poised to fall into a far deeper bear market? They could, of course. Note that while the most speculative segments of the market, including Nasdaq, have lost a third or more of their value from peak levels, the damage to other stock indexes is fairly minor so far.
The blue-chip Standard & Poor’s 500, for example, is down 11.2% from its 2000 peak--barely into “correction” territory. Even the S&P; small-stock index, down 17.1% from its peak, is still a ways from the official bear-market threshold of a 20% drop.
While valuation concerns have been a prime culprit in pulling tech stocks down, the dive in the broad market on Friday was sparked by news that consumer inflation in March rose much faster than expected.
That could give the Federal Reserve, already exceedingly antagonistic toward the stock market, more reason to become even more aggressive with its interest-rate hikes in the months ahead.
Despite what is still a booming economy--which is fueling tremendous earnings growth at many companies--if the market begins to perceive that the Fed will risk recession to stop inflation, the decline in stock prices almost certainly will continue in the short term.
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That could be awful for anyone who has every dime already in the market. But for many investors who are generating savings and investing regularly such as through a 401(k) retirement plan, falling stock prices should be viewed as a gift.
“Buy low, sell high” is still the ultimate investing strategy, after all. (Got a better idea?)
It may have been Warren Buffett who quipped long ago that stocks are the only thing most people run away from as prices drop. When any other desirable thing goes on sale, consumers step up in a big way.
But with stocks, fear overcomes greed in market downturns, and many people lose sight of long-term goals they might have held dear when prices were going up.
Still, the best reason not to buy into a declining market is if you firmly believe that prices are headed a lot lower before they have any chance of turning around.
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Which brings us back to the issue of what constitutes fair valuations for the new-economy technology companies whose long-term growth prospects still appear more exciting than those of many other businesses.
As the chart on the cover of this section shows, price-to-earnings ratios for many well-known tech shares have come down precipitously over the last few weeks. But by any measure, they’re still high.
Shares of computer chip giant Intel, for example, now are priced at about 38 times the $2.91 a share the company is expected to earn this year.
That’s down from a P/E of 50 at the stock’s peak. But it’s still nearly twice the company’s expected annual earnings growth rate over the next five years.
P/Es on much smaller, albeit faster-growing tech shares, remain far above Intel’s P/E.
If fundamentals matter again, do those valuations have to come down dramatically?
In judging where new-economy stock P/Es are headed, keep three things in mind.
First, the excitement over new companies and new business concepts may have ebbed for now, but it will be back. It always comes back. That’s America.
Second, the market always affords the fastest-growing companies valuations that are far above what is afforded the rest of the market.
Third, once-classic growth stocks like Coca-Cola and Walt Disney have continued to carry high P/Es even during multiyear non-growth periods.
Does tech deserve worse, or better, than those names?
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Panicked Markets: Where Does It End?
With Friday’s massive sell-off, the most speculative segments of the market--especially the technology sector--have lost a third or more of their value in a matter of weeks. But even with the slide in tech stock price-to-earnings ratios, the shares remain highly valued by historical standards.
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As Key Indexes Plunge ...
Percentage decline in major market indexes from their 2000 peaks:
-11.2%: S&P; 500
-12.1: Dow industrials
-13.8: S&P; mid-cap
-15.4: Wilshire 5,000
-17.1: S&P; small-cap
-31.8: Nasdaq 100
-34.2: Nasdaq composite
-36.7: Internet index*
-48.6: Amex biotech
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... Stock Valuations Slide
Price-to-earnings ratios for major tech stocks, at their 2000 price peaks and now, based on analysts’ consensus estimates for 2000 earnings per share:
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Fri. 2000 est. P/E: Stock close At peak Now Juniper Networks $158.06 2,087 1,054 Yahoo 116.00 610 283 JDS Uniphase 79.63 426 221 Broadcom 122.25 356 172 Cisco Systems 57.00 161 112 Oracle 63.52 145 102 Qualcomm 105.19 190 100 Amgen 52.75 71 49 Microsoft 74.13 71 44 Intel 110.50 50 38 S&P; 500 index 1,356.56 30 27
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* Interactive Week index
Sources: Times resarch; Zacks Investment Research (earnings estimates)
