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Paris, Wednesday, March 29, 2000

Money Managers Fuel Stock Mania

By Philip Bowring International Herald Tribune.
HONG KONG - The chasm between the Dow Jones and Nasdaq stock indexes is more than just a curiosity. It is global and dangerous, and it reflects badly on the financial services industry.

Even if the gap is beginning to close, its causes and its ill effects deserve exploring. So, too, do daily index movements of 3 to 4 percent, which suggest that many institutional investors have the perspective of day traders.

Globalization and the relatively small number of very large institutional players is transferring index movements from one market to another regardless of the actual economic conditions in the smaller ones. Remember the Asian contagion of collapsing markets? This is it in global reverse.

As usual, the United States is the front-runner, with the Dow selling at a multiple of around 23 times earnings, while the Nasdaq is somewhere well into triple digits. But it is much the same in Europe, with fantastic values attributed to phone and dot-com companies while retailers and widget makers languish. It is even the case with shares of Chinese companies listed in Hong Kong. China Telecom sells at 70 times earnings while Chinese power companies with solid records sell at five to six times earnings.

In earlier days of the tech-stock fever, it was possible to explain this by reference to the glamour of the Internet and a shortage of available stock.

Then came the ''madness of crowds'' as small investors, and day traders in particular, got swept up in the euphoria, blind to the risks but hopeful of a winning ticket to riches.

Till then it was just like any other boom and bust, with the small players moving in just as the smart money was taking its profits. But recent months have seen huge sums of mutual fund money shifting out of old-economy stocks into momentum stocks.

This is not only money dedicated by middle-class savers to the tech sector. Much was discretionary investment being moved by managers because they perceived that that was where momentum was even if they remained dubious of the tech boom. Their jobs depended on joining the pack.

But why should these managers be in momentum investing at all? By definition it puts short-term tactical guesses far ahead of assessments of valuation or long-term earnings potential, and it is dangerous.

For companies and individuals to play the momentum game with their own money is fine. But the managers are doing it with someone else's.

They are mostly judged by short-term performance. They are well paid even when they do poorly and get megabucks when they do well. So momentum playing comes naturally. But it is against the interest of clients, most of whom are saving for a retirement years, not months, away.

It will all end in tears, especially for middle-class savers who will suffer capital losses and have negligible dividends to keep them in retirement. And for the United States, at least, it is misallocating the capital that is being borrowed from abroad by the billions.

The momentum mania is also being driven by brokerage houses. They have made media stars out of a few who have been early to pick a few tech winners. But in the process they have had to throw their professional (old ethics as well as old economy) analytical tools away. Instead of realistic valuations of earnings potential, company X is described as a ''strong buy'' just because company Y in the same business sells at an even more absurd multiple of sales. Profits are little relevant.

The brokerages are run by salesmen, not researchers. Seriously negative analysis gets edited out. Salesmen love momentum.

Positive views are also in demand from the investment bankers, who make more money and have more prestige than their broker colleagues. Who wants professional valuations of tech stock public offerings to get in the way of new business? Borderline legality, not honesty, has come to define legitimate profit.

The momentum phenomenon has spread around the world because the same firms and funds are at work in London, Frankfurt, Hong Kong and Tokyo as well as New York.

The chasm between the Nasdaq and the Dow, and their equivalents elsewhere, is not so much between the old and new economies. It is between the pretension to professionalism of those entrusted with other peoples' money and their actual behavior.