Historians may look back on Y2K not for the inconvenience of
computer bugs but as the apogee of the world's first global
It is the US in particular which has lost all contact with
financial reality. But the virus of delusion, of the madness
of crowds has spread far beyond American shores. It is rampant
throughout Europe and a milder version has been infecting
Hongkong in recent weeks.
To the tech stock craze has been added a deluge of liquidity,
particularly surprising in Hongkong where money supply had
been growing at snail's pace because of a sluggish economy and
high real interest rates. How come? Ask Mr Greenspan. The man
who is credited with all kinds of economic wonders and is the
guradian against inflation has, pre-Y2K, been printing money
at a quite alarming rate. US M3 has risen by $140 bn or an
annual rate of 15% in the past two months. At the same time,
supposedly to ease global financial markets through Y2K he has
made all kinds of new repurchase arrangments available.
According to Grants Interest Rate Observer, the Fed's own
balance sheet has expanded by $30 bn since September. No
wonder a small rise in prime rate makes little impact.
This is merely more fuel for investor madness and paper-
financed takeover action, which is supposed to produce greater
efficiency but will more likely lead to debt burdens and
mammoth goodwill write-offs.
When the public loses its critical faculties, crooks and
shysters flourish and even respectable institutions believe
that there is a "new Morality" as well as a "new economy".
Let us start with the Nasdaq, the golden calf of the new
religion. This writer is no stranger to market bubbles, having
been an observer of a succession of them going back to the
late 60s Australian mining boom, through the 1973 Hongkong
phenomenon, several seasons of ramps of Malaysian penny
stocks, the Red Chip nonsense of 1997, etc. But it is the
scale of the Nasdaq bubble that is so frightening when
combined with the very high level, but not totally outlandish,
level of all other US markets, and many in Europe. Most of
Asia is thankfully exempt.
Nasdaq (US domestic stocks only) is now a US$3 trillion
market, which makes it almost as big as Tokyo and bigger than
all other markets except the $11 trillion NYSE. Yet this
market is trading on a Price earnings ratio in the region of
150, compared with around 60 in Tokyo at the height of its
bubble a decade ago. As for Nasdaq dividend yield, it is so
small -- 0.19% -- as to barely cover the cheque postage. As
example, internet portal Yahoo -- which actually has earnings
and has just been admitted to the benchmark S&P 500 index --
is selling on 1,000 current earnings and 380 times its
prospective earnings in 2001! A space odyssey indeed.
The idea that earnings do not matter, that momentum (ie follow
the crowd) is the way to invest is the most pernicious of
all the nonsense being spouted by brokers and so-called
investment advisers. Wait till these overpaid juveniles get to
age 45 with portfolios which at best (the S&P 500) have
earnings yields which match inflation and dividend yields
which are half even today's low inflation and one quarter the
Treasury bond yield. The coming tragedy meanwhile is that the
baby boomers, now around 50 and will need retirement income in
decade or are seeing their savings invested in assets with
negligible yields so that today's paper millionaires will have
pauper income when they retire.
But of course earnings, or at least their direction, do matter
even in this market which is why even mainstream companies are
bending the accounting rules to meet market expectations. For
example, as with MCIWorldcom, by omitting write-down of
goodwill on acquisitions from its headline numbers. Likewise,
Intel announced profits up 21% by departing from normal
accounting standards and omitting acquisition costs which
would have meant a small drop in profits. If giants are upto
this without much criticism, god alone knows what's happening
among the smaller players.
Dividends are another matter. Why give shareholders their due
when the managers can pump up the value of their stock options
through share buy-backs, if necessary using money borrowed at
8% to buy assets yielding 2%? It is curious how little notice
fund managers, who ought to be looking after investors'
interests, take of the quiet rape of corporations by their
executives. The explanation lies partly in unwillingness to
rock the boat and partly because mutual and pension fund
revenues mostly come from the size of assets under management
so the higher the market the more their income.
The quality of self-regulation also appears to be in decline.
Only this week (Dec 14) a US federal judge ruled that NYSE
procedure "makes a mockery" of the ban on brokers trading in
accounts in which they have an interest. As for so-called
analysts of tech stocks, they will have a lot to answer for
when it all comes crashing down. Expect a rash of billion
dollar class action suits against the brokers and investment
bankers -- and perhaps some fund managers -- now celebrating
huge year-end bonuses.
As for the follow-the-crowd mentality of fund managers, a
process encouraged by 3-month assessments of portfolios which
should be judged over ten years, or more, Hongkong itself
provides a striking reminder of their inability to think
independently. Who were the main sellers of Hang Seng index
stocks to Donald Tsang in August 1998? And who has bought them
back from him at twice the price?
Meanwhile huge disparities have opened up between the front
runners in their manic market and many perfectly good
companies which have good earnings but no "momentum". In the
US, Tenneco, a competent but unfashionable auto parts
manufacturer which was removed from the S&P 500 to make room
for Yahoo. It sells on 5 times earnings and 0.1 times revenues
(against Yahoo's 200 times revenue).
The same phenomenon exists in Hongkong. Most China stocks have
been languishing despite WTO. But China Telecom is now at 70
times earnings while mainland power companies, which mostly
have real earnings and sold growth prospects are on single
digit multiples. As for most internet and e.commerce stocks,
and the property developers trying to dress up in new clothes,
almost all are momentum driven hype. Many will never have any
revenue, let alone worthwhile profits.
This is not to decry the importance of the digital revolution,
or suggest that leaders in hardware, software and usage
will not enjoy excellent earnings growth. But the tech bubble
is the tip of an iceberg towards which investors Greenspan's
Titanic is headed, all the while celebrating Y2K.
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