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A few days later, the market has bounced back quite nicely, thank you, and Wall Street's gurus have recovered sufficiently to try to make sense of it all. Yes, the market mouthpieces are a shade less perky. But their messages are more or less consistent with what they've been saying since mid-March, when the tech sector began dropping and eventually pulled the rest of the market with it: Fasten your seatbelts -- we're in for a bumpy ride. That doesn't mean anything is fundamentally wrong with the tech sector, the economy, or Alan Greenspan. The high-tech boom that has fueled America's spectacular economic expansion is nowhere near played out, corporate earnings are strong, and inflation remains low. The New Economy is not only here to stay but is taking hold in Old Economy companies as they figure out how to use the Net to their advantage. RISKY BETS. As for the skyrocketing/free-falling market, volatility is a normal part of the investment cycle when the development of new technologies goes into hyperdrive. Investors are making bets on which new-tech purveyors will win, even before they know what the markets for those technologies will be. That sure is risky, but -- if you guess right -- rewarding over the long run. "We're in a phase that's very like the Industrial Revolution, only it's the Information Revolution, and the Internet is driving it," says Arun Kumar, senior U.S. equity strategist for Lehman Brothers. "Investors are trying to figure out who the winners and the losers are, so we'll have volatility in individual stocks and the indexes they make up." Kumar and others believe that the correction in the tech sector has pretty much bottomed out, although it's always hard to pinpoint exactly which trade marks the actual bottom. According to most market watchers, it's time to buy into the tech sector -- carefully. Investors can no longer trust that the share price of every dot-com that comes to market will rise with the tide. Assessing a business' fundamentals is back in favor. "New Economy markets are winner-take-all or winner-take-most markets," says Michael Mauboussin, a managing director and chief U.S. investment strategist at Credit Suisse First Boston. "We will see waves of failures. It happened in business-to-consumer (Net companies), it'll happen in business-to-business." NO RELIEF. These waves of failures, while they set off huge market corrections, do not signal the end of the Internet Age. "Investors' expectations [for Net stocks] were excessive, and we've experienced a healthy correction," says Mauboussin. "But traditional [Old Economy] investors should not be breathing a sigh of relief." Thanks to the Net, companies are doing business in fundamentally new ways, and Old Economy companies that try to play catchup will not necessarily vanquish their Web-based rivals. Although e-tailers' stocks have taken a beating in recent weeks, retail is a sector where the New/Old Economy divide is most telling, according to Mauboussin. The skill set needed to run a Web-based retail operation is far different from what a bricks-and-mortar retailer needs. At the front end, setting up the site -- the interface with the customer -- requires graphic designers and programmers as opposed to floor managers and interior designers. The back-end logistics are also different, with e-tailers collecting cash before they even have the inventory to ship to the customer. "The notion that Wal-Mart can flick a switch and do what Amazon does, is not realistic," says Mauboussin. "Wal-Mart is four years behind." If betting on dot-coms seems foolhardy these days, many analysts recommend buying stocks of companies that provide the Net's infrastucture. "The large-cap tech stocks like Microsoft, Intel, Sun Microsystems, and Cisco are less volatile," says Lehman Brothers' Kumar. "These companies have low debt levels, so the Fed's rate hikes are less hurtful to them. And there is robust demand for their products" -- at least as long as their customers are trying to build Net businesses. LOOK OUT AHEAD. Kumar believes the tech sector will continue to lead the stock market in 2000. He points out that in the seven previous tech corrections, the S&P 500 tech stocks corrected an average of 14%. Last week's correction of 17% was higher than the average, but lower than the biggest correction, of 20%. Still, just because the New Economy's prospects remain good and the tech sector has survived another correction doesn't mean the market's volatility is over. In fact, since 1997, volatility has increased, according to a study by Marci Rossell, a vice-president and chief economist for Oppenheimer Funds. Rossell compared the average number of volatile trading days in a year at the beginning of the '90s to the number at the end of the decade. A "volatile day" was one on which the S&P 500 moved up or down 1% or more. A "quiet day" was one when the S&P moved less than 0.5%. From 1991 to 1996, some 10% of trading days were volatile, and almost 90% were quiet. From 1997 to 1999, the percentage of volatile trading days jumped to 33%, the number of quiet days fell to 33%, and the rest were intermediate -- defined as days when the S&P moved between 0.5% and 1%. PULLING THE REINS. In part, this increased volatility reflects investors' bets on the technology boom. But other factors are at play, including day trading, the type of herd mentality among investors that ushered in the Internet Age, and the Fed's efforts to slow economic growth and control inflation. "Day traders can drive intraday volatility," says Rossell. "They follow the momentum and exacerbate the swings." At the same time, Greenspan has been pulling back the reins on the economy by raising interest rates. Although he has said he isn't using rates to cool the markets, declines like that of Apr. 14 do affect peoples' wealth and confidence. That can slow their spending and put the brakes on economic growth. Thus, the Fed's efforts to curb inflation have some economists worried. "The markets are not prepared for the intensity of the hikes the Fed is planning," says Stephen Roach, chief economist and director of global economic analysis at Morgan Stanley Dean Witter. "The Fed thinks the market has played too powerful a role in driving economic growth." Perhaps the Fed can take credit for continuing low inflation, but an increase in productivity is also an important factor. "When technology is doing well, productivity does well," says Maury Harris, a managing director and chief economist at PaineWebber. "Productivity, or output per hour worked, rose by 3% in 1999, the biggest rise in six years. If you look solely at high-tech industrial output, its productivity rose 35% last year, according to the Fed's numbers." STRONGER PACE. Productivity growth coupled with labor-force growth indicates what Harris calls the "noninflation" speed limit -- how fast the economy can grow without inflation. In part driven by the surge of senior citizens reentering the labor market, the labor supply is currently growing at about 1% a year. Add that to 3% overall productivity growth, and the economy should be able to grow at 4% annually without spurring inflation, well below the 5% or more it probably grew in the first quarter, but above the 3.5% the Fed is targeting. The tech-led market "is betting on productivity," says Harris. If the Fed tries to slow growth in the face of that, brace yourself for even greater market volatility over the next few weeks. Popper covers finance for Business Week Online |
