The 'new economy' has been embraced like never before, and the 'old economy' has been rejected. One ...
The 'new economy' has been embraced like never before, and the 'old economy' has been rejected. One market has produced some of the biggest gains and highest one-year returns in history and the other, which includes a far bigger majority of stocks, has been in a steady decline.
The new economy/old economy distinction is a significant one since most of the real growth and productivity improvement is in the new economy technology revolution sector. So much has been made of this contrast in sector performance that a new paradigm label has gained credibility along with the observation that the 'old rules do not apply anymore'. This, of course, is just another way of saying, 'it is different this time'. It is different to the extent that 'history repeats itself, but never exactly'.
What we know is new, disruptive, exciting technologies have evolved that are changing our lives as dramatically as the industrial revolution and other great milestones such as the introduction of the railroad, automobile, radio, transportation by air and the computer.
All of these new technologies had lasting impact on business and people's lives. Yet, even though these technological innovations had lasting economic impact, it was not easy to profit from them on an investment basis over the long term. The greatest investment success was always in the early stages when many companies rushed in to capitalise on the new technology, and expectations were highest. There may have been 2,000 companies producing cars in the early part of this century but only a few remained over the long-term to reward investors.
The same was true for airlines and computers. In radio, RCA was the premier company but, after its stock peaked in 1929, investors had to wait until the 1980s to see a higher price. The purpose of this bit of history is not to denigrate the new communications and internet-related technologies but to point out important new discoveries have impacted our lives materially before; but for investors it was generally not the road to riches that it seemed in the early discovery stage. New paradigms usually discover the old rules are not obsolete.
At a time when things could not be better, investors have a hard time keeping their expectations under control. Since this bull market began in 1982, the S&P 500 total return has been close to 20% annually. In the last five years, it has averaged 30%. No wonder most individual investors expect 20% returns for their stock investments for the next ten years. We are in the longest peacetime economic expansion with rising productivity, low inflation and low unemployment. No wonder we saw consumer confidence rise to the highest levels ever.
The main problem with this best-of-worlds economy and high investor confidence is it also implies high risk. Historically, when the consumer has been most confident and the investor has record commitments to stocks at the highest prices without regard to value, we were in a high-risk peaking environment. We have observed many times that the public puts the most amount of capital and borrows the most at the highest prices for an asset.
With all the talk about the market's split personality, until recently little attention has been focused on another aspect of change.
The change is the evolution from a market where the emphasis was on the highest-quality large cap growth stocks for most of the 1994-1998 period to one of steadily declining quality emphasis as prices and volume have surged to new records monthly since then.
Many of the large cap quality growth stocks are being sold from portfolios as investors search for bigger and faster gains. We not only have technology stocks with sky-high valuations, internet and genome stocks with no earnings and no early prospect of same, IP0s with instant mark-ups of 100%-to-700%, we also now have rising demand for low-priced stocks and penny stocks.
Trading volume has surged on the OTC Bulletin Board and the Pink Sheets where these lowest-quality offerings are found. Volume on the OTC Bulletin Board has gone from a daily average of 123.3 million shares in 1998 to 1.07 billion shares so far this year. Historically, this full cycle turn from emphasising the highest-quality large cap issues to speculating on the smallest, lowest-priced penny stocks has not had a good outcome.
For investors this is likely to be a particularly challenging year. The economic, monetary and inflation background is changing at a time optimism is near an all-time peak. The extreme imbalances in the stock market, plus speculative excesses in the new economy technology sector, are unlikely to be sustained without a serious correction.
While short-term rates are likely to be pushed higher, long-term Treasuries appear to have found a floor due to the Treasury's debt retirement plan. Foreign markets likely will not be immune to adjustments in the US, but still look like an attractive alternative investment outlet.
The last three months have been particularly eventful for our theme sectors. Technology has continued to be the area of the greatest gains, but clearly on a more selective basis and with more evidence of profit taking. Strength has been evolutionary in technology. Former favourites in telecom services; personal computers; telecom equipment; internet portals; e-commerce to consumers, and e-brokers have fallen out of favour, some dramatically.
Yet, emphasis continues on semiconductors, wireless hand-held appliances, broadband, satellites, fibre optics and internet business-to-business commerce. The very extended prices of these infavour areas suggests this is a time to be cutting back exposure to this theme area and waiting for better prices to add to positions in leaders.
Also, joining the excitement for future technological progress have been the biotech stocks, particularly those associated with the human genome project. This
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