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The Market Needed A Dose Of Reality...


Editorials

The Market Needed a Dose of Reality...

Welcome to the start of the first major market correction of the New Economy. The correction in price may not be over, but a correction in expectations has already occurred. Despite the recoup on Turbulent Tuesday, a 13.6% fall in the Nasdaq in three hours, triggering margin calls all the way down, was enough to give pause to even the most speculative day trader. Real earnings suddenly matter a lot more than dot-com dreams. A long-overdue rotation looks to be under way that reflects a strong shift to quality (page 40). It is a healthy wringing out of excess speculation. But while a return to more rational valuation is to be applauded, the violent market gyrations are a reminder that the New Economy has by no means put an end to volatility.

Markets overshoot, of course, and the New Economy brings new temptations. A business world driven by hot technologies and innovations is one in which investors need to place lots of bets. It's impossible to know exactly which models will succeed or which technologies will get traction. Whipped up by the Wall Street hype machine, it is easy for average investors to get carried away, buy into initial public offerings at extravagant prices, and bid up certain Net stocks to ridiculous heights. People begin to accept silly notions of valuation, and high-tech stocks soar beyond any reason. Overshooting on the upside is always a danger in a technologically vibrant economy.

So too, perhaps, is overshooting on the downside. In recent months, venture capitalists and professional investors have quietly decided to move out of many business-to-commerce dot-coms that show few prospects of profitability anytime soon. Funds have been flowing into more promising business-to-business startups, Net infrastructure companies, and virtually all New Economy stocks showing real earnings. Safer Old Economy equities that have traditionally turned a good profit have also attracted professional money. But day traders and individual momentum investors continued to play fast and loose, keeping many high-tech stocks unreasonably high even as the pros retreated. That meant that when the break came in the markets, there was little support and prices fell like stones. On Tuesday, it was scary, perhaps scary enough to begin tempering the excesses of momentum investing.

The truth is, the Internet has been in an unreal world, and investors have been willing participants. Eternal verities of capitalism concerning competition, information, and valuation have been ignored. All the hype hid the questionable practices upon which many new dot-com businesses were based.Return to top

...And That Goes Double for Dot-Coms

The Internet Revolution is unquestionably a marvel. But the pioneers in Silicon Valley must face up to the fact that traditional commercial and legal precepts that govern capitalism must also apply to the Net. Indeed, given its novelty and power, they must apply especially to the Net. For example:-- Privacy. Many business-to-consumer dot-coms are based on a business model that invades privacy, aggregates personal data, and markets the information without an individual's consent. Privacy was not supposed to matter on the Internet. It certainly does. Personal lawsuits and inquiries by the Federal Trade Commission into how DoubleClick Inc. and other online outfits collected and used information led investors to push their stocks down. CEOs now promise to protect privacy in the future.-- Transparency. Many dot-coms are playing pretend when it comes to their revenues. They claim the full price of airline tickets or hotel rooms as revenues when all they do is link up buyer and seller. Others claim bartered ads. Still others are booking long-term revenues up front. Sadly, their auditors have agreed, arguing that the Internet is somehow different. The Securities & Exchange Commission doesn't see it that way. The agency has leaned hard on them to follow the rules. Now outfits like drkoop.com, CDnow.com, Peapod.com, and MicroStrategy are restating their real revenues--much lower--and investors are sending their stocks down.-- Patents. Some dot-com companies, such as priceline.com and Amazon, patent widespread business methods and software techniques to create a monopoly and inhibit rivals. Again, the Net is said to be such a special place, the obvious can be patented. The U.S. Patent Office, understaffed and overwhelmed, initially agreed. But under pressure from online competitors, it has changed its mind. Online or offline, patenting the obvious won't be allowed.-- Monopoly. Economists and Net gurus argue that the need for standardization and the power of network externalities justifies monopolies on the Net. Again, the argument is that the Net is a special place. Not according to competitors who complained bitterly to the Justice Dept. about Microsoft. The courts have now ruled that Microsoft violated the 100-year-old Sherman Anti-Trust Act. Abuse of monopoly isn't allowed on the Net, after all. Investors sent Microsoft's stock down.

Each problem--privacy, transparency, patents, monopoly--has hurt particular stocks. Together they explain a large part of the recent correction in Nasdaq. High-tech entrepreneurs must address these problems as the price for continued access to capital. As long as they persist, there is a real danger that markets will continue to be volatile.Return to top


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