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>From Businessweek...
JW
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http://www.businessweek.com/@@@nfLcGcQJHsRvgAA/premium/00_16
/b3677048.htm
ECONOMIC VIEWPOINT
Yes, Virginia, There Is a Speculative Bubble
ROBERT KUTTNER
Is the long-awaited stock market correction at hand, or is
this the bull market that refuses to die? Lately, a lot of
smart people have concluded that the market has peaked. Yet
in the first quarter, investors put a record $120 billion
into equity funds, most of it into aggressive, high-growth
funds. When exuberance is truly irrational, it tends to be
impervious to evidence.
PaineWebber Inc. recently ran a full-page ad warning
investors to be prudent. ''We have said it countless times
before,'' the ad declared, ''and we will say it again: In
the long run, only two things determine stock
prices--earnings and p-e. Yet many of these 'new new
industrials' have no earnings.'' Robert J. Shiller's new
book, Irrational Exuberance, cites a 1999 Barron's poll,
which asked money managers: ''Is the stock market a
speculative bubble?'' Amazingly, 72% answered yes. Even the
bullish Abby Joseph Cohen of Goldman, Sachs & Co. recently
announced that she has pared her exposure to stocks.
But investors don't want to believe the party is over. At
first, they fled ''old economy'' stocks for the technology
sector. They fled Internet retailers for high-tech
business-to-business companies. Then they fled back into
traditional blue chips. (Did somebody say ''herd
behavior''?) What they have not done yet, despite five
interest rate hikes, is to flee stocks for money-market
instruments.
NEW FAITH. Optimists insist that the New Economy really is
so new that historically outlandish valuations are
justified. They cite three key factors. The Internet economy
portends a new era of permanently higher productivity
growth, higher economic growth, and higher profits. The
baby-boomer money pouring into the stock market will keep
share values up. The new faith in ''stocks for the long
run'' will prevent panic selling.
The pessimists, led by Shiller, suggest that the present
level of share prices is a classic bubble. He likens the
market to a ''naturally occurring Ponzi scheme,'' a
self-deception by giddy investors who assume unsustainable
returns, on the premise that other investors will be even
giddier.
At some point, however, a stock price has to reflect
earnings. And earnings plainly cannot possibly justify
present multiples. Shiller cites one company, eToys Inc.,
established in 1997 to sell toys over the Internet. Its
stock value soon soared to $8 billion, higher than industry
leader Toys 'R' Us--even though Toys 'R' Us had 400 times
its sales and ran a healthy profit of $376 million in fiscal
year 1998, while eToys ran a loss. The price-earnings ratio
of the market as a whole is now far in excess of 1929
levels.
Enthusiasts of Internet retailing mistakenly assume that
each new company will enjoy monopoly profits. But regulatory
policy and the laws of economics are necessarily
constraining that euphoria. The Securities & Exchange
Commission has been jawboning accounting firms to take their
jobs seriously. As a consequence, a growing number of
dot-coms are reporting lower actual revenues and poorer
prospects for future earnings. The Justice Dept. is also
insisting that antitrust rules be applied to the New
Economy. And the patent laws are requiring that generic
innovations such as video streaming be made widely available
rather than hoarded. While some innovators such as
Amazon.com Inc., with its patented ''one-click'' checkout
system, have managed to defend unique business methods,
these monopolies are being challenged as well. The Internet
invites price comparison, which shaves profits.
This market has been cruising for a major correction. One
trigger could be the Microsoft case and the implication that
monopoly profits are not an inevitable aspect of the
Internet economy.
As I write these words, I am preparing remarks for the White
House Conference on the New Economy. What is surely new
about the New Economy is higher levels of productivity
growth, made possible by information technology. This is no
small achievement. It means that we can enjoy near full
employment with low levels of inflation and steadily rising
real living standards.
But the Internet economy has not repealed the timeless rule
that the worth of an enterprise must reflect its earnings
capacity. It would be better for the real economy if some
air came out of the stock market slowly. Alas, that is not
the nature of bubbles--particularly when all that's
sustaining the equity markets is the prospect of even higher
share prices and not dividends. When the herd decides that
the bubble can expand no more, the herd psychology is to
cash out fast. In the long run, of course, the market comes
back. But try telling that to a stampede.
By ROBERT KUTTNER
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