Milton Friedman, the fabled University of Chicago economist, once pointed out that there are no business cycles, only ups and downs.
The yo-yo performance of the stock market indicates nothing more serious than this: the hard-eyed investment brokers who populate Bay and Wall streets took leave of their senses over the past couple of years, pushing share values into the sky. Every once in a while, investors realize what they’ve done and that detonates a massive sell-off. Despite last week’s partial recovery, the stock dips over the past eight months still add up to a crash of no mean proportions.
But it’s no reason for panic. The markets and the economy, which once operated in tandem, now have little connection, and Canada’s business outlook remains relatively serene. The fact that the dot-com bubble is either inflating or bursting proves there never was a New Economy, just companies trying to survive in a world grown so competitive that even Darwin’s jungle ethic seems tame by comparison. The high-tech market spree, highlighted by five years of annual 30-per-cent or more gains on the Nasdaq composite index, cannot and will not last forever.
The late Andy Sarlos, one of Bay Street’s shrewdest traders, once told me that while many investors compare stock markets with gambling casinos, the analogy isn’t valid. “Casinos,” he pointed out, “have rules.” Then he added an interesting afterthought: “Actually, there is one stock market rule that never fails. If you hail a cab on Bay Street and the driver starts giving you market tips, turn around, drive back to your office and sell everything you can.”
Over the past few seasons, ordinarily rational traders have become convinced that a new age has dawned that will negate the forces of gravity. Stock values will rise forever, goes their mantra, with shares eventually trading at 50 or 100 times projected earnings. Meanwhile, the market climbs wildly up or plunges wildly down, but neither move has much to do with its fundamentals. It no longer seems to matter if companies actually make money, as long as there is the hint of future revenues. A new breed of do-it-yourself day traders, who make up their own rules, encourage the fluctuations.
Before the most recent upswing, few stocks within the new knowledge category were spared a bashing. At one point, even mighty Microsoft was down 62 per cent. For Canadian investors, the biggest disappointment was the burnt sacrifice of Nortel Networks, our prize 21st-century high-tech icon. Its share value went from $123 in July to $45 last week before closing at $49. The plunge was set off when the company hinted there might be a slight slowdown in third-quarter sales. That set off the panic selling, even though Nortel’s
pace-setting sales of fibre-optic equipment were, at the time, up 90 per cent from the previous year. The market whizzes had expected at least 125-per-cent growth, and started to sell short. Since that bloodbath, sanity has returned. Among senior analysts recently polled by Zacks Investment Research on Wall Street, which now decides Nortel’s stock price, 33 rated Nortel a buy, with two ranking it a hold and only one calling it a sell.
Worst hit, of course, have been the high-tech initial public offerings that were based on untested claims of technical and marketing breakthroughs. The IPO, which was once a legitimate step in the evolution of a company from birth to maturity, became an instrument of validation that had little connection to real value. As London’s Financial Times columnist Peter Martin noted at year-end, “This surge of money produced a mispricing of capital, because when capital is nearly free, the need to discriminate between new ideas disappears.”
In one way, the IPO explosion (and its still likely implosion) is good news, because other market bubbles of this magnitude have traditionally been financed by the banking system, and when they burst, the entire economic structure was threatened. This time, the only victims will be the IPO shareholders. That will be a relatively harmless way of soaking up large-scale losses without any need for public bailouts.
Having been frightened by the sharp market swings, investors from now on may be expected to judge new issues on a more conventional basis, such as reading balance sheets instead of believing their attendant hype. Such old-fashioned ideas as examining net earnings instead of gross revenues, of insisting on real asset valuations and assessing working capital ratios, will become fashionable again.
At the moment, chances are that the market uncertainties will not spread beyond the stock exchanges because Canada’s fundamental economic indicators remain relatively strong. With our annual gross domestic product increase for 2000 expected to reach a healthy 4.6 per cent, predictions for the current year are slightly lower but equally solid. The supremacy of real business that depends on human endeavour is bound to reassert itself, while stock market levels find their way back to saner territory. Instead of a New Economy and an Old Economy, we must aim for a Real Economy.
Divining the direction of the stock market is a mug’s game. But it’s useful to keep in mind Baron Nathan Rothschild’s cool admonition during some long-ago crash, when he advised a friend: “The best time to buy is when blood is running in the streets.”
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