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The Almighty Buck

Irrational Exuberance 191

Irrational Exuberance -- a provocative, even scary new book by Yale economist Robert J. Shiller -- is sending shock waves through Wall Street. Shiller argues that the techno-fueled stock-market boom is based on emotion, rumor, pyschology and herd instincts (like excitement about the Net), rather than on any rational facts or data -- and that it can't last. In fact, he writes, technology may be driving the market mad. If he's right, the market has to fall, and technology companies will be among those most significantly affected. (Read More).

The conventional wisdom has it that technology is only good news for the American economy: Productivity and profits are rising. Investors, newly empowered by digitally-acquired information and transactional software tools, are enthusiastically pumping capital into companies they think will grow in value. And lots of these investors believe that the likeliest stocks to increase in value are technology companies. The tide of easily-available information allows them to feel well-informed and well-prepared, and reduces their fears of overpaying.

"Because knowledge once gained is irreversible," Federal Reserve Chairman Alan Greenspan told economists in a recent speech, "so too are the lowered risk premiums."

But in Irrational Exuberance, published by Princeton University Press, Shiller argues that stock markets are being driven by psychology and emotion -- in particular by an "irrational exuberance" fueled not by information but by impulse, herd behavior, dinner party chatter, intuition, media hype, fear of being cut out -- everything, in fact, but reason. Thus, he explains, there is a growing unease about the alleged, techno-driven Long Boom underway in American markets.

By historical standards, Shiller says, the U.S. stock market has rocketed to astonishing high levels. But if the history of high market valuations is any guide, the public may be profoundly disappointed with the market performance in the years to come.

This isn't just an economic issue for profit-hungry stock trawlers. How the market is valued affects the economic, political and social policies questions of society at large (and affects technology industries in particular). If a stock's value is exaggerated or climbs artificially high, then the country may invest too much money in business start-ups and too little in infrastructure, research, education, and other forms of "human capital." Thus if people lose faith in the market's future, they may associate that disappointment with technology.

The explosive growth of the Net and Web in the second half of the 90's has affected how Americans view the economy in general, and markets in particular, writes Shiller.

The Mosaic browser first became available to the public in l994. That date more or less marks the beginning of the Web, but only a few people had access to it. Large numbers of Web users didn't appear until l997, marking the very same years when the NASDAQ stock price index took off, tripling to the beginning of 2000, and price-ratio earnings entered unprecedently high territory. Net technology, writes Shiller, is unusual because it's a source of entertainment and preoccupation for so many people. It conveys, he argues, the sense of a changed future, of mastery of the world, which makes it plausible for people to assume that it also had profound economic importance.

"But we may question what impact the Internet and the computer revolution should have on the valuation of existing corporations," writes Shiller. "New technology will always have an impact on the market, but should it really raise the value of existing companies, given that those existing companies do not have a monopoly on the new technology?" The notion that existing companies will benefit from the Net revolution is belied, he argues, by the stories of E*Trade.com, Amazon.com and other upstarts, who didn't even exist a few years ago. What matters for a stock market boom isn't the reality of the Internet, but rather the "public impression" that the revolution creates.

This is a risky way to approach markets, he argues.

It also distorts the way people -- especially Americans -- view technology. The fixation on technology as force for wealth and economic growth is yet another distraction from the growing list of critical technological issues -- corporatization of technology, genetics, nano-technology, bio-tech, AI, supercomputing -- and other issues and concerns that are rarely discussed in mainstream media or political forums.

Shiller cautions that we might also become complacent in maintaining savings, improving the Social Security system or providing other social safety nets. We might also lose the opportunity to use our improving financial status to create slutions to real risks many Americans face -- to their homes, schools, cities and livelihoods.

This irrational exuberance (and its resulting complacency) is not only driven by the national obsession with computing technology, but affects the future of technology in a particularly direct way. The Internet, for all the hype, is still in primitive, nascent form. Some of the new technologies computing may spawn -- genetic research, nano-technology, bio-tech, supercomputing, AI -- will require vast amounts of capital that only a healthy stock market environment can generate. The collapse of this market, or doubts that it will grow and prosper, could have a devastating impact on the development of these new technologies.

Shiller warns in his book that a long boom may not be in the cards. By l999, he writes, the Dow Jones industrial average had more than tripled in five years. But personal income and gross domestic product each rose less than 30%, and almost half that increase was due to inflation. Corporate profits rose less than 30%. The size of the stock market's gains, he therefore cautions, may be unwarranted and unlikely to persist.

The mainstream media, as usual, has been far from helpful, lurching from one hysteria -- sex and thievery online -- to another -- dot.com investment hype. When it comes to grasping the impact of technology on society, the public has from the first stirrings of the Internet, pretty much been left on its own. One of the conclusions it has reached is that anybody with a computer and a modem can be a savvy, well-informed and ultimately profitable investor. This idea is at the core of the "irrational exuberance" Shiller is writing about. It it's true, we're in for many good and prosperous years, at least in terms of the economy. If it's not, and this feeling is illusory ...

Contemporary technology has, without a doubt, challenged historic ideas of how the economy works. Computing in particular is not only changing commerce, but revolutionizing access to markets by individual market investors, thus changing the markets themselves. The atmosphere surrounding technology is super-heated. It seems that half the country is buying tech stocks, the other feeling as if it should and could. E-trading has been in part responsible for the explosive growth in Americans use of the Net in the past two years, and also in the expectations of many Americans that technology is synonymous with growth and wealth.

Most of the current generation of technology leaders and workers has never really known recession, depression, or even much in the way of serious reversal. Unless people begin to invest in diverse and different ways, that could change, says Shiller.

He pleads for the expansion of the number and variety of securities and markets for them, to allow people to protect themselves against major economic risks. He favors new "macro-markets" that would include markets for long-term claims on national incomes for the world's major countries, and for truly diversified global portfolios, instead of limiting investors to securities that are claims on corporate profits, as is the case now.

"A doctor in Des Moines could take a short position in medical incomes and a short position in expensive Des Moines single-family homes," writes Shiller, "therefore effectively insuring against risks to both sustenance and shelter. At the same time, the doctor could buy securities linked to incomes around the world and to real estate around the world." These macro-markets would be bigger than current markets and far more diverse in the risks they present to people.

Irrational exuberance seems the right term for the atmosphere surrounding tech-driven markets. Millions of Americans are now using the Net to break open access to markets, even as they've driven prices up, they have clearly exposed themselves and their futures to risk.

It's almost impossible to pick up a newspaper or magazine without seeing more hype about the techno-boom and the wealth it's generating. This is dangerous, Shiller warns; it's a serious mistake for political and business leaders to acquiesce in such high stock valuations. It thus follows that it's not a good idea for the rest of us either.

"All of our plans for the future, as individuals and as a society, hinge on our perceived wealth," he warns, "and those plans can be thrown into disarray if much of that wealth evaporates tomorrow."


If you want, you can purchase this book at fatbrain.com.

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Irrational Exuberance

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  • by Anonymous Coward
    I don't think you have ever been through a total collapse. Remember Asia three years ago? Could it happen here? Japan is still technically bankrupt even after ten years and billions in bought US securities. Russia has still been under since 1991. China faces revolution if the state companies go bankrupt in the next few years. Pile on US re-financed stuff /mortgages/credit card debt/ margins from Ameritrade/retirement money/higher interest rates-- what do you get? Limitless growth globally? The stockmarket will reflect a reversion to the mean. All the Y2k nuts who stockpiled may have been right afterall.
  • This is something I had suspected all along once the huge ".com IPO's" started occuring. As everyone else starts "following the herd" and investing everything into tech stocks, we see this nice rise in the market and everyone is happy - for now.

    As history has proved itself before, as the market gets pretty huge gains in a very short period of time, we get what is called a market correction. We see sharp drops in the market in a short period of time, like a day or so. It "corrects" itself. Some economists theorize that the casual investor sees himself making huge amounts of money in a short period of time figures he should just sell right away and take that profit, since everyone else is getting rich, and they may get the same idea. So a few people do this, and others start it as well, then the snowball effect occurs.

    Remember back in June or was is July of '98? This same thing had occured. The tech stocks were rising sharply and over a few days the DJIA dropped 500+ points over a couple days. The Dow Jones Industrial Average was more or less composed of technology stocks at the time. For those of you who don't know, the DJIA is basically an index of the top 10 (or is it 30?) or so stocks basically, and they use that index's performance to "guage" the market and see how it is doing. (If you want a better measuring stick, use the S&P 500.) Since all of these or most anyway were tech stocks it drove the DJIAA way down and everyone started to panic a little bit, selling their K-Mart and McDonalds stocks as well.

    I will be investing in a few technology stocks myself, but my portfolio will more or less consist of companies that produce things that we humans need for survival, not just want. (i.e., paper, textiles, livestock industries)
  • From my non-economist chair I've always seen the stock market as seperate from the "reality" of businesses. I think what this "irrational exhuberance" and the rocketing of the market upward despite little or no earnings has blown the schism between the market and reality open to the point where people see the differences. Really, the market has never reflected earnings or anything of the sort, it's only reflected people's desire to own a stock and most of the people owning the stock cared about the P/E ratios and all that. Now that the masses are investing, the market has been opened to people who don't know a Price to Earnings ratio from a box of Rice Chex. This means that the "reality" of earnings and profit _really_ doesn't matter because it doesn't even figure into the calculations of thousands of investors. Most institutional investors see this as terrible but I wonder if it really is? Just because The Market is way out of whack with Reality instead of tenuously connected like it was before, does this mean anything?

    The important thing I think is that people realize the schism between The Reality and The Market and invest that way. If you know that your stock's price isn't related to the business's performance you can invest differently. You can begin to invest based on what you think others will do, rather than what you think the business will do.

    I hate to fall into the trap of applying the Open Source model to everything but I'm going to anyway. The old investors, the guy in the Datek commercial pleading "You don't see the quotes as the market is moving," are like the Closed Source software vendors seeing the new Open Source guys coming up. To them, the Open Source way is the death of software, the death of security, a new way that will never work. To the institutional investor, these New Investors with their Internet stocks and zero/negative profits are going to wreck havoc on the world but I don't think it will. I think the new investors are changing the ways things happen but if people see the change it doesn't have to cause anybody any sleepless nights or recessions.

    If any economists read this, I'm not one of you and I might not know what I'm talking about. But I don't think I'm the only one thinking this. I'm also trying to coalate my thoughts on this so if this was a bit rambling it's only because I haven't solidified my ideas yet. I welcome all discussion.

  • Ask yourself: if a heavy-equipment manufacturer had revenue, earnings, and growth identical to Yahoo!, would you pay $150 a share for it?

    Of course you wouldn't, but that doesn't mean Yahoo is overvalued. The big difference between Yahoo and a heavy-equipment manufacturer is the rate of growth. Heavy-equipment manufacturers have been around for quite a long time and as such the market for their products is pretty well saturated and growing at a linear (I'm guessing here) rate if at all. Yahoo, on the other hand, has an exponentially growing market and their earnings have seen commensurate growth. The market factors this into the price of their stock by giving them a higher price to earnings ratio than companies with less dramatic growth. Now, whether or not a P/E ratio of 100 is too high is another question which I am not going to attempt to answer, my point is that Yahoo's P/E ratio should definitely be higher than traditional companies with the same level of earnings because their growth rate is much greater.

  • Oh, because it's on a web page it's something new and great with huge growth? Not really, it's the other way around, anybody can do what yahoo does. There are tons of other search engines just like yahoo out now that have shown this.

    Oh brother... I can't believe I have to explain this in Slashdot of all places. Are you aware of the tremendous growth in number of users that the web and internet have been experiencing over the past several years? It's practically following its own version of Moore's law doubling every few months (I don't know the exact numbers off the top of my head). When your target audience grows at an exponential rate so does your business, at least when you're on top like Yahoo is. The target audience for books, magazines, and other traditional media is not growing anywhere near as fast as the number of internet users - you have to have been under a rock for nearly the past decade to think otherwise. Even if Yahoo's percentage of marketshare remains constant among search engines they will experience tremendous growth by shear virtue of the fact that the market pool of users is growing rapidly. (I would argue that Yahoo's percentage market share will increase over time due to their highly successful branding efforts, but that is a totally separate issue and not necessary to see why they will continue to experience high growth).

  • To clarify, when I say that Yahoo will continue to experience tremendous growth I am referring to their revenues, not their stock price. A P/E ratio of is really frickin high even for a copmany in hyper-growth and I'm not going to venture a guess as to what the actual value should be (perhaps 100 is reasonable - I don't know).
  • I disagree. By short-selling Des Moines properties, and Medicine incomes, he is buying insurance, therefore he is decreasing the variance of his portfolio and hence his overall risk.

    If he gets squeezed out of his shorts, its cool, because his property and revenue will have gone up. If his property and revenue go down, its cool, because his shorts will have made money.


    Well, it's not quite as simple as all that. If he's forced to cover his short position, he's just lost his insurance, at the most crucial point (when the market may be close to its peak).

    That kind of insurance (although I'm having trouble visualizing the exact kind of instrument this would be) is useful in relatively stable times (when systemic risk is low) for protection against individual catastrophes (e. g. the doctor becoming disabled). For times when systemic risk is high (economic turmoil), though, things can get dicey. What happens if, for example, the counterparty can't pay off the transaction? I pay a premium for insurance coverage, and then the insurance companies suddenly find themselves facing more claims than they have resources to pay. Now what?

    Well, insurance companies themselves can buy insurance. That's called "reinsurance". That's all well and good, but suppose things get so bad that the reinsurers go belly up?

    Now we're really in the soup. At this point, something that's supposed to blunt (negative feedback) the harmful effects of a catastrophe is no longer doing so. In fact, the mass claims from this one systemic catastrophe weaken the insurance companies' ability to pay off unrelated claims, which causes ripple effects through the rest of the economy. Now we're in a positive feedback cycle.

    The whole point is that in extreme circumstances, something that looks like protection may actually have the reverse effect if all of the effects are not carefully considered. This kind of thing is not intended to protect against individual misfortune in a stable economic climate, but rather a mass misfortune in a very unstable environment. The normal rules might not apply then.

    (You'll note that I cast this in insurance terms, because that's really what it is, in theory. I have real trouble figuring out who would issue such a security. I suppose a group of doctors would get together and offer bonds with interest paid from future earnings. That would certainly enable doctors to lay off some risk, which is the whole idea. But that would surely be an extremely high risk security, what with moral hazard and all that. I think that this particular example of Shiller's is weird.)

  • I thought that the general consensus among mainstream economists is that the stock market IS being irrationally exhubrent and is threatening the long term sustainability of the current expansion.

    Translation: they're cheering Greenspan on. "Come on, Al! make it a 50 this time!"

    Research theories from academics don't typically represent the day in and day out reality that applied economists deal with. [Applied economists are typically financiers, finance politicians, clued-in managers, consultants, and the odd techie who happens to have an economics degree.. :) ]

  • Looks like this guy has read Anthony Trollop's "The Way We Live Now".

    If you replace railways in Trollop's book for 'Internet' in this book you see some striking similarities between then and now.

  • Will there be any stores in the future? Sooner or later someone will create a global system where you can compare prices directly, and this will ultimately force manufacturers to sell their goods directly. "Real-life" shops might have a chance to survive, because they offer an exhibition of products the make it possible to pick the product up immediately. But online, there will only be no use for shops. Competition will remove all middlemen between the customer and the manufacturer. Only those that offer extra-service, a real benefit to the customer have a chance.
  • This was timely advice...a month and a half ago. 100's of billions of dollars worth of exhuberance has been wrung out of the market already.
  • Schiller's reasoning is circular, and making a potential crisis out of "irrational exuberance" lends a shade of irony to his proposed solution: more, and more sophiticated, derivatives. His nod to solving social problems (with the the taxes on the derivatives, I suppose) gives him the PC stamp of aproval as opposed to us hard-hearted sort that think putting their own kids through college comes first. "Hey, you! You'll hurt yourself on Datek. Come listen to my plan, it'll only cost another 2% of GDP in taxation, and you'll feel safer." Yeah right.
  • It's an inevitable fact of life -- nothing ventured, nothing gained. Every form of investment carries with it a degree of risk. If this is scary to you, Mr. Katz, perhaps you should buy gold and hole it up in a vault somewhere.
  • You may have even written a paper yourself about the statistical non correlation between the overall economy and the markets' performance. A bubble is a bubble whether you call it the next technological revolution or latest tulip craze. Does anyone remember the 80's when moribund companies were valued more as dismembered chunks each to be sold off and ultimately dismembered again and sold off again, and so on?

    All invesment entails a degree of risk. What IS occuring now is that many companies with no direct experience in the dotcom world are going off and leveraging the hype. Anybody own Starbucks recently? A coffee shop on the net? WTF sense does that make? So in effect what happens is the nominal risk of going off into a new market with a new business model using technology you don't understand well and don't directly control tends to normalize. The risk to an AT&T converges toward that of monkeysoutmyass.com. With valuations this high even the basic dollar value associated with those two risks is roughly the same. So of course the market becomes more volatile. It is experiencing what you statisticians call autocorrelation. That is, my estimate of what a stock will do is based on my estimate of what other analysts think similar risk rated companies will do which is based on what some other analysts think my company will do. Typically wild swings in value are compounded by a lack of understanding whether today's earnings announcement for company A has any bearing at all on company B - - but hey they've both got dotcom in the name so let's treat them the same. Evident this is the importance of 'whisper numbers'. These are earnings and price estimates that are based on unfounded or unattributable information or sources or guesses about guesses about guesses. What you see happening with whisper numbers is that a company will announce projected next quarter earnings, the whisper numbers come in higher or lower. When the time comes for an accounting and that company announces that that quarters earning were in fact what they projected the stock price drops if the whisper number eg. 'the secret real deal' was higher. If the whisper number was lower than what the company publically projected then the market already hammered the price and the announcement of on-target earnings only reaffirms that market actually knew what it was doing in the first place. Rational? No.

    Now take the other case, the case of hype over substance. Each investment is evaluated in the context of that set of alternative investments that perform better or worse. For every stock you have to decide whether you think this given stock will outperform any number of other stocks given the investment goals you ascribe to. So if what you want is money market rate + 20% over the next 6 months you determine for yourself whether there is an acceptable likihood of that actually happening. If your goal is instant millionaire then you evaluate that stock in a group of other stocks you think are roughly equal in their ability to make you an instant millionaire. Now as most people know - the bigger you are the harder you hit. So being the first or nearly so in a market even if its only for a few months can give you enormous advantage. With valuations going up this rapidly the first Yahoo is already several billion dollars ahead of the second Yahoo. In fact the difference is so large that the net effect is to crowd out the investment in any other potential competitor. Investing in the second Yahoo is for VC's because for every 2 dozen companies they fund if one pays off even partially like a Yahoo then the loser dogs don't count. IS this rational - actually, yes it is.

    Now we move on to third case which is a side effect of the other two. That case is where post IPO companies of different maturities and expertise get dragged in the same direction, usually down, as the rest of the market independant of every other fact. This one is bit more complex because it introduces the effect of institutional investors. Say for example you have two stocks: monkeysoutmyass.com and mail.com. Both went public but one has a rational business model, good management, real earnings growth, generally good relationships with customers while the other company really is 5 guys and a business plan on a bar napkin, a lot of overtime, pursuasive pitches to the analysts and some seed capital. An announcement goes out about some market or sector or company not directly related to this but probably has some tangential effect. Institutional investors decide to rejuggle the portfolios because GiantHardwareCompany.com - a major player and someone who should know announces that next quarter earning will be lower than the previous quarter. Not lower than expected mind you - because this IS the expectation, but just lower, slightly. The reason could be something as obscure as difficulty in procuring controller chips from the one Taiwanese factory that just fell into the ocean from the last earthquake to something closer to home like consumers don't like or understand your recent marketing push to something mundane <and unstated> like our R+D head is going through a midlife crisis and cashed out and moved to Monte Carlo....well you get the point. Immediately the institutional investors pick from their category menus because making individual decisions about thousands of stocks is impossible. So small portions of whole sectors go into the sell basket driving the price down. Ergo your two companies described above both drop below the IPO price for no obvious reason. IS this rational? Sort of; at least it's predictable.

    Is the market full of hype, hot air, ignorance, herd mentality, misinformation? Yeah sure. And as long as banks are paying 2.2% on CD's while charging 8-9% on long term consumer debt people will continue to invest in the market because any other option is a GUARANTEED net loss factoring in the CPI and taxes.
  • The good companies will grow and adapt and thrive(long term), the bad companies or the fly-by-nights will die. There will be lots of ups and downs in between.

    While this sounds like common sense, the reality is that even one company in a hundred is stable enough to survive a market crash, there are tens of thousands of people who invested in the other 99. So what difference does it make that one company survived? Those tens of thousands of other people are shit out of luck, and given the fact that over 50% of Americans own stock in one form or another today, that's a recipe for a massive depression. It's one thing to be smug; it's another to be starving.

  • The majority of all new companies fail. Why should .Coms be any different? Usually, they fail due to lack of funding (profits) and/or mismanagement. It's surprising how many people forget this simple rule of entrepreneurship, especially the people that make their living working with such businesses.

    Chris
  • ..in that (from the way Katz described it) technology is all hype, and that investors who are buying in now are setting themselves up for a fall.

    To my mind, internet-age technology is fundamentally changing the way that we need to look at companies and their valuations. Coca-Cola, 3M, and other old-economy companies do not have the huge growthrates that companies like Nortel and Nokia show.. Nortel grew revenues 48% this past first quarter. Compare that to Daimler-Chrysler, which grew revenues 17% in the first quarter. Both of these are huge companies, yet Nortel almost triples their growth rate.

    Yes, I think some stocks are overvalued, but the recent crushing losses on the NASDAQ took care of a lot of the high-flyers with no tangible business like pets.com, drkoop.com, etc. A Cisco, a Nortel, a Nokia.. these companies are going to continue to have unbelievable growth rates over the next ten years as the internet becomes more and more part of our day-to-day existance. I personally would like to be a part of that.

    -s
  • FUD

    I wish people would stop using this word out of context. FUD stands for "Fear, Uncertainty, and doubt." As in "if you buy a non-Microsoft product, you never know what bad things will happen." FUD is designed to get people to buy the dominant product due to the fear that the alternative has unseen downsides, the uncertainty about the products quality, and the doubt that the product will work as advertised.

    My statement says nothing about Microsoft's products or those of its competitors. It might be pro-Microsoft propoganda, but it isn't FUD. Please use the word in its appropriate context.

    Cisco (CSCO) is America's most valuable company and can be considered more successful and monopolistic than MSFT in every sense of the word.

    I think a large part of the reason Cisco hasn't been targeted is that it's not as high-profile as Microsoft. People see the Microsoft logo every time they start up their computers, and software developers' lives revolve around changes MS makes to its API's. Cisco may be just as ubiquitous, but neither users nor developers deal as directly with their products. A cisco router sits in the background minding its own business. And so no one is pushing the DOJ to go after them.

    I don't particularly want to get into another long discussion of the merits of antitrust law. Even most defenders of antitrust will concede that once a company gets a large enough market share, the rules change and the company isn't allowed to engage in various "unfair" activities. Whether you agree with these restrictions or not, they *do* reduce the payoff for starting the next Microsoft.

    Yet it is not being harassed by the DOJ because "crush the competition by any means necessary" is not their guiding principle of operation.

    This is and should be the guiding principle of any company. That's what competition is all about: you try to take as much market share as possible from your competitors, and you use any non-violent means at your disposal to do it. It's oxymoronic to expect companies to compete but not compete "too hard." All companies try to crush their competitors. If they didn't, their competitors would likely crush them. That's the way the free market works.
  • I recently read a book that pointed out that speculative booms, and crashes, have followed every major advance in technology. Two of the examples given were railroads and radio. Investors threw money at everything that moved, in the hope of getting rich. Most of the new companies failed or were acquired at cheap prices.
  • Do the manufacturers want to sell goods directly to the public? Selling small quantities and holding the customer's hand is expensive. Many manufacturers would rather ship a truckload of goods to a wholesaler or retailer, and let them deal with the end users.
  • Anyone who believes this, ought to be very happy. Any time you can identify irrationality in how the market is working, you can make money off of it by merely buying and selling stocks or other financial implements rationally.

    In this case, it is argued that the stock market is "too high". OK, if the stock market is too high, that must mean that some specific stock(s) are too high. Identify the most extreme ones.

    Short them.

    There; you should be a millionaire in short order. Be sure to go way out on margin, you want to lever every bit of money to get the greatest return.

    Now, to Mr Katz and anyone else who really believes that the markets are valued wrong: why are you not out earning zillions?

    Could it be you don't really believe what you are saying? Could it be that talk is cheap? Could it be that money talks -- bullshit walks?

    The stock market is unlike other domains where pundits get to flap their jaws all the time to no apparent effect. In the stock market, you put up or shut up. Have you ever noticed why stock analysts on news shows are always so much more wishy-washy than, say, political commentators? That's why.

    Jon, how much have you earned in the stock market lately?

  • Heh, Dude ... It would be rather strange if World Water Forum suddenly declared that the next war will be fought over ... grain and therefore WWF is not really needed anymore. These people live off donations, based on scaring off people ... They have to come up with some gruesome scenario just to stay in "business".

  • These are some very good comments. I'm surprised and delighted to see so many slashdotters with knowledgeable and insightful opinions on the stock market.

    Just one question: when will all these great comments be 'borrowed' and sold in Katz's new book, 'Voices from the Stock Market'?

  • I'm not surprised that the revelations about the truth behind the driving forces of the stock market came as a surprise to Jon Katz. As for others, I would think that any educated person who follows the stock market closely would regard this as common knowledge. This is how the stock market works.

    "Shock waves".. oh yeah. Jon, I hope the next "shocking" thing you learn has something to do with "water" and "electricity". Please.

  • I understand that it is important for you to miss the point in order to feel good about yourself, but perhaps you should think about what you're saying before you trust everything to blind faith. Just because you unconditionally believe in a "God" doesn't mean you can get away with unconditional belief of how you think american society works. For example, you say

    This shows itself in the US's love affair with the gun - USians view the right to take other's life with ease as being an integral part of the culture, and fight viciously any attempts to take this "right" away. Despite the highest murder rate in the Western world, and any number of high school massacres, USians still seem to think that the owning of guns, a tool used only for violence, is something that is required for civilisation.

    But that assumes that americans cherish the right to own guns because they glorify the distruction of life. This is simply not the case. Americans cherish the right to own guns because this is a young country whose citizens remember governmental oppression, and the right to own guns is a symbolic representation of the fact that americans will not allow their freedom to be taken from them again. Don't allow blind faith to rule your life. Try reading a newspaper rather then just the bible. Open your eyes!
  • This [theobvious.com] article on Katz is rather interesting.

    --
    GroundAndPound.com [groundandpound.com] News and info for martial artists of all styles.
  • Study history, investment has hardly been fueled by what is the most sane, easy, or otherwise intelligent risks. Ever thought of the railroad? Damn, that was one expensive as hell thing to build and maintain. But gee, sure did change the world. The difference now is that we do not have just a Rockafellers, there are thousands and thousands of small investors. From day traders to people who invest in a 401k or simple stock plan. This book probably points out the obvious bullshit that has, and always *WILL* be the difference is now anyone can invest. More people = more emotion.

    Stuffy, pompous investors do not like the idea of the "average idiot" investing in the stock market. The only way that they can continue to make money is to influence the marketplace so that companies that they do not see having any intrinsic value will insta-fail, and ones that "produce value" will survive, grow, and end up making them money.

    Don't buy into the lies and utter BS. Average investor joe schmow does not want to learn about every company that they invest 500 bucks in, so of course the market is more lead by feeling now than in the past. But is that so wrong? As John Katz is so overbearing to point out every time that he can, corporate America is destroying the world - perhaps companies fueled by what the consumer wants & needs are the wave of the future... perhaps not -- only time will tell.

    Just think of it like this, how many people have actually saved money, and got useful information from companies such as Amazon, Yahoo!, etc. These companies will make what is due them (either more or less) as they change management strategies, and explore various methods for gaining a profit. We will see where the future leads on this.

  • Me, I invest. I'm one of those people that goes to http://www.fool.com/, doesn't buy the hot thing, changes his investments yearly based on mathematical calculations, and doesn't trust hype. I'm also a webmaster/programmer, so I tend to see both sides.

    A statement like this book is needed, sadly, because many people do not see all sides, nor have a sense of history. Not everyone is an economist, a technologist, or a historian, and their sources of information are limited.

    From what I've seen, the technoboom started AFTER the economy began to pick up, making me wonder if the economy fueled the Internet growth more that people realize. Perhaps technological hype and truth help perpetuate it, but people need to consider multiple factors in any economic boom.

    Is there benefit in the new economy? Sure. It's just competing with hype, misunderstanding, and wishful thinking. I've seen plenty of IT/Web projects pour huge amounts of money down technoholes when simpler and cheaper solutions would have produced better results. I've seen my fellow technologists take advantage of this hype, delivering terrible solutions for hideous fees.

    Will it crash? My guess is its going to be more of a forced landing as the air in the hype baloon bleeds off - and books like this help start it so it happens slowly, not in a disastrous crunch. I figure that, in about a year, values will be more sane and people will be looking for real value.

    Then again, this may be my OWN wishful thinking.
  • Hell, perhaps I should have when I invested in Corel.

    Funny, i'm trying to *avoid* investing in Corel. Here's hoping the merger falls through *cross fingers*
  • One need only to look at the Dutch tulip craze to see the pattern....

    Do you know of a good book on that?
  • Down as much as 35% of it's 52 week high, currently somewhat higher but still waaaayyyy down. Wait, hold on, I'm about to predict LAST YEAR's super bowl winner.... its, its, the RAMS!

    Er ... sure, NASDAQ is down from its high. But its PE ratio is still insane by historic standards, and the DOW isn't down significantly (although its PE ratio is insane as well).

    Maybe we're at the start of a "soft landing". But I wouldn't bet on it.
  • Now, to Mr Katz and anyone else who really believes that the markets are valued wrong: why are you not out earning zillions?

    Insufficient capital to play. I've got less than $10K in the bank at the moment; while I could earn some with that, it's not going to make me a millionaire.
  • One possible solution is for government regulation to mandate minimum values for trading, outside of the reach of small investors. Another solution could be to delay trading by 48 hours on small trades, minimizing the "herd" effects.

    Thereby allowing only the "big boys" to play, and ensuring that if the stock market *does* take a dump, the small investors will get screwed the most.

    I'd be more in favor of increasing the margin-backing requirement (you're only allowed to have a certain percentage of your portfolio out on margin; i'd decrease that percentage); this would protect people from the behavior most likely to hurt them if the market dumps.
  • Unfortunately, Shiller joins a long list of public figures who continue to be listened to, even after they've been proven wrong

    *Proven* wrong? That's a slightly strong statement, isn't it? The thing is, we really don't *know* if we're experiencing a speculative bubble or not. Certainly it seems unlikely *to me* that the value of companies in the US increased by *500%* in the last ten years (based on the value of the DOW, you would assume that was true). But that doesn't mean we're experiencing a bubble; something else might be going on. Nobody knows for sure; most economists seem puzzled and confused.
  • Nothing like a market crash to do some serious bottom feeding, then dump the stock after the market recovers.

    That sounds nice, but what if you get a market like the early 1930s, which just goes down, down, down, for years.

  • Eventually there will be no more money for the herds to throw at the stock market. Then we're in for it. And the CEOs and higher-ups who make out on the IPOs will be laughing all the way to the bank.

  • While this sounds like common sense, the reality is that even one company in a hundred is stable enough to survive a market crash, there are tens of thousands of people who invested in the other 99.

    Actually I was responding to a post which claimed that we would likely see many market corrections leading to a bear market, not a crash. I personally don't believe that a "crash" like the one leading into the depression will happen. However a bear market will happen at some time, and yes, the companies who are not generating revenue will eventually die.

    Over the long term the market has always come back from corrections so if you buy the Coke's and GM's you will do just fine. If you invest in the high-risk get-rich-quick stocks then you better know your at risk when you go in and you better be prepared for the worst.
  • If amazon.com went bankrupt, would all the
    stockholders fight over all those bookracks?

    How much do you think the bookracks will sell
    for, they have been used.

    See what I mean?
  • It seems any reasonable investor with only the minimum level of information has known much of this for years, however, in case you havn't noticed many of the stocks which were causing this trouble have retreated significantly in the last few months.

    There will always be companies that are valued higher or lower than perhaps their financials indicate they should be, but this is the nature of a speculative stock market.

    Investors are free to invest in the FUTURE success of a company or industry that is not reflected in the current financial performance. Likewise, investors are free to sell or go short on any position even if it's financials currently indicate future profitability.

    The inflation figure quoted in the article of 30% is ludicrous. If inflation was 30%, corn flakes that cost $4.00 in 1995, would now cost $17.93 to just break even.

    As far as industry valuation for Internet and technology stocks. Yes, some stocks are quite overvalued due to investor hyperactivity, however, some of the technology companies are good companies with good financials. There are quite a few examples of profitable, or mostly profitable pillars of the industry, they have been around and in the market for years, they provide good products for good value, and they have a demostrated track record of growth and performance. Some of these companies seem to be fairly appropriatly valued based on the current economy.

    If the current valuation is due to irationality in the tech sector, how do you explain the 10-15 year dow trend of 20-30% growth? I think we can explain a great deal of this with the IRA and the 401(k). These programs have shifted vast amounts of financial resources from government pensions into the stock market, and as more and more people enter the economy as workers with retirement hopes, more and more money enters the stock market. Still more growth comes from the social popularity of internet investing, and stock purchases as a whole, employee stock options, and more.

    These factors, in addition to investor emotionality, have driven solid growth for the past decade or so. The real question is, how much of the current value is based only on emotion and irrational hopes for an industry.

    I believe much less than this article predicts, but more than the current market indicates.

    Therefore, on a 2-3 year trend I would guess we will see a slight decrease in the current growth rate, but not quite a reversal in the growth trend.

    John

  • Analysis for AMAZON COM INC:
    Based on data from SEC schedule EX-27.1 for the period JAN-01-1999 to DEC-31-1999,
    the predicted bankrupcy date is Dec 22, 2000 which is 228 days away.

    That's when they run out of cash.

    Better add a couple of days. I've been casually tracking the sales ranking of Irrational Exuberance on amazon.com for the last week or two--I work at a university press, and it's always fun to see a university press get a best-seller--and it had declined from #22 to somewhere in the #50s. But today it's back up to #16.

    Apparently its sales ranking got /.ed! ('Fess up: how many of you bought the book as a result of this thread?)

  • I wonder if all the madness during the ending of E-Bay auctions is similar to this. You know, people paying several dollars over the street value for various items...

    I must admit I have almost been caught up in this at times. Then I slow down and realize that I don't need to pay $180 dollars for this 8 port switch when I can go and get a new one at the store for less.
  • Seems all the people peddling survival wear this time last year need a new line, and they have found it either in impending weather/geological disasters or in economic crash or collapse. Greenspan's now-famous "irrational exuberance" phrase drew a large crowd of people waiting to see the train wreck. These hucksters are rarely chastized if the future proves them wrong, and they usually make vague enough claims either to postpone evaluation until people tire and forget or to find one or two tenuous points to claim "I was RIGHT!!!".

    Of course every economist will have a different outlook on the short-term prospects of the market, especially within the tech sector. Shiller has a sound foundation for his position, I'm sure. What was the quote back around 1929..."when cab drivers start giving you stock tips, it's time to get out." Now we have e-brokerages featuring hairdressers trading market advice in their commercials. Pretty interesting parallel.

    But just as irrational exuberance can lead to bad exposure, so can an irrational exit strategy. I have little sympathy for the day-traders and other hoping to make what has always been a long-term investment into their get-rich-quick plan. We are now into a new step in economic education in this market. First we learned that you can make money. Now we are learning that a few safeguards are necessary in order to protect that money and grow it over the long term. Not at all new principles but a new lesson for people who had until now not bothered to learn it.

  • Sure. Maybe. It could be irrational exuberance, or it very well could be as many people suspect great new opportunities to invest in technologies that will change the world as we know it (web, telecom, nanotech, biotech, etc.) Sure, valuations are sky high. Just like they were when the automobile first hit. There were tens of automobile companies in America that people invested in, thinking, "Wow, this is great new technology that will change the world." It did (do you own an auto?). But not all those early auto companies survived. In fact, look at the Big 3 in America. Consolidation happened as the market matured. Consolidation will happen to all the aforementioned technology markets. The trick is to invest in those companies who will do the consolidating and survive in the end. Then we can be back with our lives and Newsweek can stop reporting abou the stock market and begin reporting about more salient issues like, what is Brad Pitt wearing today and what new disgusting fad have teenagers picked up to screw with their parents heads.
  • Down as much as 35% of it's 52 week high, currently somewhat higher but still waaaayyyy down. Wait, hold on, I'm about to predict LAST YEAR's super bowl winner.... its, its, the RAMS!
  • The Sweat Sock Forum has concluded that the next world war will be over access to laundry-deficient athletic facilities.

    And yet, every day, people all over the world thoughtlessly toss this vital resource into the nearest washing machine or (in developing countries) scrub it on rocks in streams.

    Our secret is gamma-irradiated cow manure
    Mitsubishi ad
  • If he gets squeezed out of his shorts, its cool, because his property and revenue will have gone up.

    Except he has to use his new equity and revenue to cover his shorts... cutting into his profit, netting him $0, or worse. Doesn't sound like a winning proposition to me. Unless you have a crystal ball beowulf cluster, you're better off not investing at all.

    I can't imagine shorting something unless there were a reason to expect it to decrease in value, because I expect every worthwhile investment to increase in value in the long term. The risk in shorting an investment is infinite, the risk in going long equals the initial investment; the benefits of the two are inverse.

  • And what's up with the post itself? My sarcasm tags must not be working because it seems like he's saying "look at the gradual curve on the charts, it's not very steep". Of course not, it's a logrithmic chart.

    Well, sparky, I think Cally's trying to point out that we're currently experiencing a correction as we speak.

    Remember, the book was published 3/2000, before the last correction! -maybe it really did have a big impact on Wall Street, kind of a self-fulfilling prophesy.

    Naaah. There have been bears yelling that the market was overvalued and that the bubble would burst when the Dow was at 5000 in 1996. Its been four years and the Dow has more than doubled in value since then, suddenly the market corrects, and we consider these bears to be "market gurus"? I don't think so.

    When you flip a coin, 50% of the time, you are going to be right.

  • Personally, I look on the possibility of a serious correction in the markets as a buying opportunity. The secret is to find the companies that are fundamentally strong.

    If people are going to use history as an indication of future performance (which is what this guy Schiller is doing), then you will see that the long-term trend of the stock market is BULLISH.

    Unless the planet suddenly regresses back to the Middle Ages, technological advances will always provide greater levels of production, output and efficiencies that will drive businesses upward.

    Despite all the crashes, recessions and busts for whatever reasons, the market has continued to climb higher and higher, and chances are, it will continue this trend. If you put your money in a properly diversified portfolio that includes the top companies of several different industries, (such as the S&P500 index stock) you should be good for the long-term - and thats all it boils down to.

    Everything else is a crapshoot.

  • Well, it's not quite as simple as all that. If he's forced to cover his short position, he's just lost his insurance, at the most crucial point (when the market may be close to its peak).

    Substitute short sales with puts. Conceptually the same, just different instruments. Gradate the expiration dates of the puts so when one expires, the next one takes over.

    Downside is also finite.

    Now we're really in the soup. At this point, something that's supposed to blunt (negative feedback) the harmful effects of a catastrophe is no longer doing so. In fact, the mass claims from this one systemic catastrophe weaken the insurance companies' ability to pay off unrelated claims, which causes ripple effects through the rest of the economy.

    Yes, and if the world blew up, insurance companies would be screwed too.

    Unfortunately, the market consists of networks and channels than span both horizontally and vertically. If Microsoft were to suddenly go under, we should expect so would the exclusive Microsoft product reseller, as well as the software company that specializes in developing Microsoft applications. You can't grow the crop, if the soil ain't fertile.

    Since we don't get major global economic meltdowns too often, I would argue that, overall, insurance and insurance companies work to decrease risk more than they increase risk.

    I have real trouble figuring out who would issue such a security.

    Ginnie Mae, Fannie Mae, and Sallie Mae, just to name a few. The "Mortgage-backed securites", "Asset-backed securities", "Collateralized Mortgage Obligations", and "Real Estate Investment Trust" markets are what is driving the real estate market nowadays.

    By bundling up and issuing partial ownership on assets and returns, you are dividing and distributing the same total amount of risk as before, but to a much larger number of people.
    Securities markets work on this very principle.

  • Next, banks have all sorts of regulations which limits how much they can "bet" on the stock market. Unfortunately ( and at no worse possible time ), many of these restrictions are being lifted so that the poor banks can compete in this very same "Irrationally Exuberant" market.

    If you're referring to the Glass-Steagall Act, it was repealed because it was obsolete, and it didn't work. The U.S. was the only nation with a law restricting banks from engaging in investment activities, while countries like Germany, U.K. and Japan set their banks loose to do whatever business they wanted. It hobbled the U.S. banks' ability to compete in its own country against foreign banks. The Glass-Steagal Act was part of a knee-jerk, reactionary reform, that really didn't need to be implemented. Besides, banks have been finding loopholes in the Act (like creating holding companies) and have been exploiting them for decades.

    There would, of course be the serious drying up investment funds, but even though this will reduce the total amount of money ( mainly M3+ ), it will not immediately mean the loss of revenue ( unlike a bank failure ); merely the loss of earing assets and expansionary policy. Growth will probably become negative for a while, but I don't necessarily see massive amounts of firm failures. Just the growth dependant ones ( such as new firms still in debt, still waiting for a profitable quarter ).

    I for one am glad that I own foreign stock. The globalization of markets is a stabilizing force, and I think fund managers that are sufficiently diversified will be able to weather any major downturns.

  • Except he has to use his new equity and revenue to cover his shorts... cutting into his profit, netting him $0, or worse. Doesn't sound like a winning proposition to me. Unless you have a crystal ball beowulf cluster, you're better off not investing at all.

    Of course the doctor's not going to hedge himself at full parity with shorts. Then it becomes a zero-sum position! (In fact, less than zero if you include transaction fees).

    Ideally, the doctor would short a certain percentage of his property values and revenues in order to offset a percentage of his losses -- should a loss occur. In this way, he has put a limit on how much money he can lose, but he has also put a cap on how much he can make if his property goes up.

    The moral of the story is that he has sacrificed reward in order to decrease his risk. Each person has a different threshold on how much risk they can take, and some people (however hard it may be to believe) are willing to forgo soaring profits, in order to prevent devastating losses.

    I can't imagine shorting something unless there were a reason to expect it to decrease in value, because I expect every worthwhile investment to increase in value in the long term. The risk in shorting an investment is infinite, the risk in going long equals the initial investment; the benefits of the two are inverse.

    Who do you think you are anyway, Karnak? How do you know that every worthwhile investment is going to increase in value in the long term? Uncertainty is inherent in every security.

    Yes. Technically a short sale has infinite downside. But a long position has infinite upside and they cancel each other out quite nicely, thus removing a great deal of uncertainty.

    Besides, I haven't seen many stock prices hit infinity lately, have you?

  • Hasn't this happend a few times already?
    -GreySoul
  • ok, the clarify now that I have post #1...

    I have always felt that 'net stocks are unstable and volitile...that's what makes them fun, but so many people have their lives staked on this, when it does fall ... it's not a happy day, last summer that guy in Atlanta went crazy, he was a technology day trader wasn't he? we've already seen how hard a slip in MS stocks can affect wallstreet, this has been happening in a smaller scale for years now. While I dont predict a one day all out bottoming out of tech stocks, it does have a dominoe efect, which just proves the herd mentality. But for now, I know that I gots money in the bank, and the money in stocks cant really hurt that (for me)....tradeing is a risk, it's high stakes gambling on an international level, make sure you're out before the dealer pulls out his gun and shoots everyone :)
    -Doug
  • Uh.....isn't 3.5% less than 7%? Isn't 1998 a couple years back?
    <P>
  • People are no different today than they were 250 years ago.

  • Investors are no different today then they were 250 years ago, either.

    They just like to pretend they are as they pump money into the latest bubble.

  • Chili. It was initially called a success, though I don't know how it is doing now since the chilean economy stopped growing so much a couple years back.

  • > All I can say is don't allow your societal brainwashing to rule your life. The truth is out there if you can ignore your society's attempts to make it politically correct.

    You mean like the fact there is no law that REQUIRES a person to have a Social Security Number, a Driver's License, Marriage License, etc, but yet you still can Work, Travel and get married without the government's permission ;-)
  • Does OOGA stand for Object Oriented Genetic Algorithum?
  • Why should you? The behavior of your market can't be blamed on you.

    Well, my public education apparently should not be blamed on me either. *grin*.

    Yes, I meant trite. That'll teach me to preview my post while I'm on the phone with three different people with downed servers! :P
    ---
    icq:2057699
    seumas.com

  • Um. I was talking about Richard Smalley, the 1996 Nobel Laureate in Chemistry [nobelprizes.com], Richard Smalley.

    Okay. No I wasn't. ;)
    ---
    icq:2057699
    seumas.com

  • I don't mean to sound contrite, but is this really surprising to anyone? Didn't anybody learn anything from 1929?

    Granted, it was a different time and a different scenerio, but you don't need to be an economics major to realize that people choose their investments much the way they choose their dish at an ice-cream parlor.

    The goal has never been to invest in a company for their goals or their achievements, but for the potential perception the market may eventually have for them.

    The market brings to my mind the warm fuzzies of Richard Smalley and the I'm Okay, You're Okay skits from Saturday Night Live. The only thing that matters is that you keep telling yourself that you're a good person, a winner, a success and that, gosh darn it, people love you.

    And, in a nutshell, that's how the market of the last decade (at least) and this next decade ebbs and flows. Through self-pride and reinforced self-delusion.
    ---
    icq:2057699
    seumas.com

  • that used to be the buzz-statement during the 80's, anytime a talking head was asked almost anything re: the future, they were "cautiously optimistic". Personally I enjoy reckless abandon to irrational exuberance .... ;)
  • Of course it's a log scale. Oh look there's just been a big correction and the market now appears to be back on the long term trend line.

    I was going to indulge in a long Katz rant but then I thoughtr, what's the point ?

    The idea that tech stocks are wildly over-valued isn't exactly a big secret. The phrase "irrational exurberance" itself was comes from Alan Greenspan[1], who's been trying to talk it down for at least 3 years AFAIK.

    ( [1] Chairman of the Federal Reserve for the benefit of the ignorant.)
    Camaron de la Isla [flamenco-world.com] 'When I sing with pleasure, my

  • Irony: it's sorta like coppery, but a bit darker ?
    Camaron de la Isla [flamenco-world.com] 'When I sing with pleasure, my
  • Actually, there is a reason. The stock values of many of these firms is based heavily on the expectations of future earnings. The lesson of the Microsoft case is that if a company is too successful, it will be punished. Therefore, the breakup of Microsoft sets a precedent that hurts the prospects for other high-growth stocks.

    More government regulation is a bad thing for the industry, and the antitrust case is government regulation. The market is reflecting this.
  • Would that be at all like picking up some guy's book and falling for it hook, line, and sinker, then running to your computer to churn out an article to spread the book's wisdom for all to see?

    I mean, maybe it's the most fabulous book ever written, but you couldn't find one little point over which to disagree with him? Do you think you might be contributing to the herd mentality by showering it with praise while challenging none of Mr. Shiller's ideas? Jimmy Jones and L. Ron Hubbard could hardly have asked for any better PR than you gave Mr. Schiller.

    Irrational exuberance, indeed.

    Cheers,
    ZicoKnows@hotmail.com

  • I laugh out loud when I hear of yet another wonder theory in the field of economics, remember Hedge Funds? The great way to make a profit guarenteed.... didn't work did it?

    It didn't? There have been some well-publicized failures, but the last I checked there was no indication that Hedge Funds as a whole were losers.

    But it should be pointed out that Hedge Funds were based on economic theory that actually suggested not that you could always make a profit, but that you could neutralize certain kinds of risks. This thinking starts with the assumption that prices contain all the information we have about the prices of securities, and that in general arbitrage should (therefore) be impossible, since if there were any inconsistencies between the prices of certain securities, the market would quickly suck them dry.

    As it turns out, there are some short-lived inconsistancies to exploit, and that's where Hedge Funds try to make their money. The problems arise when you try to leverage your ability to make these kind of gains (use borrowed money to make the investments needed), and when you depend on a lack of outside manipulation of the underlying values. The latter is where some of the biggest disasters have happened: some non-market force has intervened to set or keep a particular price, invalidating your expectation that two securities would inevitably come to be worth the same thing within a given temporal interval. Things take longer than "they should have", somebody calls a loan or two, and boom.

    But the amazing thing about Hedge funds is that they don't depend (theoretically) on the long-run perfomance of anything, so that they should do okay in any setting. Except settings where a non-market force can irresistably keep a price differential open.

  • Inflation is good for the masses? Can I have some of whatever you are smoking?

    I've lived through inflationary periods in the USA. They hurt the poor and working classes more than the wealthy. Prices always go up faster, and more often, than wages. Interest rates make mortgages unaffordable. Anyone on a fixed income is truly screwed.

  • Amen to that my brother. The good companies will grow and adapt and thrive(long term), the bad companies or the fly-by-nights will die. There will be lots of ups and downs in between.

    This is a brave new world, the computer revolution has begun and it's going to forever change the world. We have to realize that alot of these insane company market-caps are based on future earnings. The ones that don't have future earnings will die. It's plain and simple.

    So the moral to the story is: invest in good companies and if your investing in tech stocks don't put in any money you are going to need in the near future.
  • it doesn't explain fully why the Dow Jones has also been increasing in recent years

    Baby boomer retirement funds.

  • The 'herd' who are trading from their home computer will nearly instantly begin selling their stocks

    You seem to be labouring under the impression that Joe Punter and the are worth their current prices. Not because of what they're doing now, but because they're taking up the market share, ready for world domination in the future (OK, a little strong, but you get the picture). A foot in the door now will save megabucks in the future, both in terms of development costs and in terms of keeping customers.

    Shops will shut and more effort will be put into selling on-line. Perhaps not next year, or in five years, but maybe in ten this'll start hitting. What does concern me, is the depression which will happen when retail jobs do start disappearing more quickly.

    Nick.
  • The main message of this book is obvious to anyone who really takes a good look at the current market. Technology stocks are way over valued and prices are being driven by hype more than anything else. It is still a good idea to put some of your long term investing into the market (dollar cost averaging and all that) but always hedge your bets by diversifying and puting money into some *safe* investments. My formula is:

    I try to always fund my IRA or Keogh when the market has just had a big correction (i.e. I bargain hunt).

    I keep an emergancy *warchest* of funds (at least three months of income) in a money market index account.

    I keep some less liquid funds in the highest yield CDs I can find (currently around 8 percent).

    I invest in real estate by buying rental properties or investing in a real estate trust. Currently I own one duplex and part of a future residential subdivision.

    A good rule of thumb is that your percentage of investment in the stock market should slide in an inverse ratio with your age. Something like:

    100 - age = percent to keep in the market

    Depending on the level of risk you are willing to live with, you might pick a different number than 100 to subtract from.

    This system seems to work for me, but I am not a financial expert, so take it with grain of salt. :-)

    Later,

    Thad

  • it will drop.

    Saying the current climate cannot last is a bit of a timing game, isn't it? There's a reason its called the business cycle, after all.

    That said, the old name for a recession -- a "panic" really captures the nature of an economy in which productive resources increasingly go idle why people's needs and wants increasingly become unmet. Everyone can see this is a bad thing. Now thanks to Mr. Greenspan, we have a phase for the opposite thing -- "irrational exuberance". I suspect that it's a good thing while it lasts.
  • Anybody with a little common sense has already drawn that conclusion. Do you really need a finance or econimics degree to figure this out?
    One need only to look at the Dutch tulip craze to see the pattern....
  • 2) Even if he shorted, the price of these securities would continue to rise in the short term, squeezing him (forcing him to cover his short position by buying the securities at a loss).

    The net effect is that our hypothetical doctor is more exposed, not less exposed, to risk.

    I disagree. By short-selling Des Moines properties, and Medicine incomes, he is buying insurance, therefore he is decreasing the variance of his portfolio and hence his overall risk.

    If he gets squeezed out of his shorts, its cool, because his property and revenue will have gone up. If his property and revenue go down, its cool, because his shorts will have made money.

    Its really quite simple.

  • You can find many examples of this sort of behavior in the classic book on the subject Extaordinary Popular Delusions and the Madness of Crowds [barnesandnoble.com]

    As you imply, this is not a new thing. This sort of thing has gone on for centuries. (Hell, likely millenia.) It is caused by the unfortunate tendency of the human animal to let optimism override good sense when it comes to profit.

    Anyone wanting to invest in tech should read the above book. (Hell, perhaps I should have when I invested in Corel. Perhaps I would have sold instead of watching all of my profit vanish. But that's another story...)

    What is really interesting about all this is that there are other areas of the market that seem undervalued, because all of the money is chasing tech stocks.

  • Resession is acomming. The severity is yet to be determined. Thankfully there are a couple guards against a full blown American style depression.

    First of all, the money supply is being controlled more effectively than back in the day. There may still be more bugs in the Fed's monitoring system, but they at least wont sit idlely by as M1 declines like they did in the 30s.

    Next, banks have all sorts of regulations which limits how much they can "bet" on the stock market. Unfortunately ( and at no worse possible time ), many of these restrictions are being lifted so that the poor banks can compete in this very same "Irrationally Exuberant" market. Thankfully only the soundest of the banks are being allowed, though I'm sure their hurt interests will have outreaching effects.

    We may see bank failures / mergers, but this was already in the wind throughout the 90s ( lots of regulations have been put into place that all but encourages this ). So long as banks do not contribute to the contraction of the money supply.

    What I can see happening, however, is that people pulling out of the market ( those that are lucky at any rate ) will hold their money in the form of cash. This is just as bad as making runs on banks, at least in terms of the money supply.

    There would, of course be the serious drying up investment funds, but even though this will reduce the total amount of money ( mainly M3+ ), it will not immediately mean the loss of revenue ( unlike a bank failure ); merely the loss of earing assets and expansionary policy. Growth will probably become negative for a while, but I don't necessarily see massive amounts of firm failures. Just the growth dependant ones ( such as new firms still in debt, still waiting for a profitable quarter ).

    Of course consumer confidence will be seriously shaken and consumption will decline. This will add to the cycle and further the recession. The good part is that we can deal with these sorts of recessions. Assuming that the Fed acts promptly and lowers rates sufficiently and people don't panic world-wide ( foreign makets pulling out, people defaulting on loans, etc ), then we'll be able to pull through. The stability of the market is going to be shredded cheese for a while though ( unless you stay away from tech, et. al )
  • Well, *duh*

    This is what everybody with a bit of sense in her or himself knew since somwhere in '98.
    If you look closely at the companies making up the NASDAQ, you'd find that their value is based largely on the fact that somewhere in the near future investors expect them to grow as large as microsof or AOL.
    Now that might have been possible in 1997 or so (for companies to grow as large and dominant as Microsoft or AOL) but not anymore. So we have a large body of tech companies (in wich we all own stocks) that, to justify their combined value have to grow significantly faster than the market they're in. Problem is, their combined value already makes up a large part of the market. So right now a large part (I'd say more than half) of the market has to grow way faster than said market. Which, of course, is mathematically impossible. Of course we are not stupid, so we just "fail" to notice that and keep pouring our money (which is based on the value of our stocks or stock options) into tech stocks to get more money to put into stocks etc. etc. etc....

    This of course only goes as far as the point at wich somebody says: "hey, but wait a minute, what are the odds of those companies actually growing to twice the size of microsoft?"

    Which, appearantly, is right about now. (the funk soul brother :)
    So:
    "run everybody, run and hide while you can, or you'll get splattered by the remnants of exploding soap bubble economies and soap in your eyes sucks."

    Basically this Shiller guy gave the game away.
    He's a traitor!
    All investors run to your attorneys to be the first to file suit against him for your damages, that should at least keep the second most important part of the american economy running.
    *sigh* back to lawschool again, and I was just beginning to enjoy this internet thing.....

  • I was just looking at the NASDAQ index while reading this from Jon Katz and boom. The NASDAQ is down almost 2%! Is Katz being read by everyone?
  • Ahh yes, the ingorant bliss of the self-fulfilling propehcy. This boom that we are feeling in the markets today is a very strong one. The momentum gained from this is in fact from a feeling of optimism that the current wave of technological improvements will usher in waves upon waves of greater socital change and prosperity. And how much of this so far has turned out to be false? We have seen the wide reaching impacts of greater technology: more jobs, lesser unemployment, and a greater ecomonmy. In our capitalist society, this direct translates into greater prosperity and ease of life on the household level. Companies like Intel, Microsoft, Apple, Sun, and IBM have seen and largely contributed to this gain? Why? Because their enthusiasm has spread throughout the marketplace.

    What i believe Mr. Shilling's folly to be is that he is assuming because of his pessimism and dissatisfaction with technology, that the markets innovation with the Web is somehow grossly unjustified. Right now, i will agree that there are surreal feelings of this prosperity, and thus comes with it a large doubt: "Is this boom for real?", or "Are we doing the right thing?" In such a situation, the market is justified in making a reality check, but i believe only to find out that yes, we have made considerable progress and the technology saturation is unbelievable to the extent that small changes and updates to our technology base will affect millions of people.

    Innovation is defined as the application of a new solution to a situation. TCP/IP is a perfect example. We have used this technology for years in the US. The government designed it so that information would not get lost on their networks. Today we trade stock with it! That is an innovation. The failure of the "dot-com's", as they are called, is that they fail to innovate. Companies such as e-bay, or e-trade, or amazon.com, have hung in there (sometimes very narrowly), because of that innovation.

    Mr Shiller, to you i say this: perception is reality in the sense that you are only as important as people think you are. The political and social ramifications of technology are such that it by default, makes it important to our lives. Technology needs time to mature, and its getting its day. People are starting to see the reality of the situation past the initial phase of excitement. The Microsoft trial, along with other checking factors, such as the dissatisfaction that you display, are going to weed out the strong from the weak. Afterwards, the few technology bases that will survive the boom will come out to be strong industry leaders.

    Investing in tech these days means investing in the velocity of our future. By making your statements you in essense say, we cant move as fast as we want to because we dont know whats going to happen long term. That is the very strength of innovation, the force that you seem to overlook so easily.

    --jay bonci

  • Why does Katz always feel the need to use l instead of 1?

    I think Katz is just, in his own way, protesting the whole `1337 h4x0r3r movement. Or, maybe he's an agent of the letters intending to recover lost territory from the evil digits.

    -pf

  • Well I only read the first paragraph, but I think it gives me a good idea of the rest of the article.

    I certainly can't imagine that this is news to anyone. Tech stocks have traditionally been high-risk, high-return. In recent years, things have gotten totally out of hand. Almost the entire market valuation of computer-related stocks (especially the "dot-coms") is now based on air and hype. The companies aren't designed to be stable, and in many cases, not even to generate a profit. (possibly not even offer a product, which is really sad)

    Ultimately, there's going to have to be a severe revaluation of the market. If it happens in a short period, it's going to be close to a full blown crash. Expect the Dow-Jones to drop 50% or more in a single day if panic sets in.

    In the meantime, some people are going to get stinkingly rich on the market instability. That's what the stock market is all about!

    So, um....where's the news again?

  • I've been saying that for some time. See my Downside.com [downside.com]. Of course there's a bubble. In fact, it's already burst; we're seeing a long, slow decline in most of last year's hot Internet stocks. We may or may not see a big crash where prices drop in a single day or week, but we are seeing a slow decline, a few percent per week.

    Schiller's "hey, let's have active markets in everything, so you can speculate in house price trends online, and that will fix the problem" is totally bogus. (But then, I'm only reading Katz's review, which may be wrong.)

    Meanwhile, I'm working on a new tool for Downside which does some simple cash-flow analysis for money-losing companies. Here's some early output:

    Analysis for AMAZON COM INC:
    Based on data from SEC schedule EX-27.1 for the period JAN-01-1999 to DEC-31-1999,
    the predicted bankrupcy date is Dec 22, 2000 which is 228 days away.

    That's when they run out of cash.

    Something drastic has to happen to a company in that situation. The options are dilution, taking on debt, bankruptcy, major cutbacks, or acquisition on unfavorable terms, all of which clobber current shareholders. It's not pretty. There is an endgame to the Internet mania, and it's not too far away.

    As I keep telling people, "Losing money on every sale and making it up on volume is a joke, not a business plan."

  • This is slightly OT, but worth mentioning anyway since the book is titled "Irrational Exuberance." A few years back, there was a widely circulated rumor that Alan Greenspan had said that there was "irrational exuberance" in the market, and that to a certain extent this was the reason for its success. It was, however, just that--a rumor. Greenspan never used that phrase, although he did make a statement which suggested something along the same lines. One of the primary sources disseminating news of his statement paraphrased him, and this in turn was picked up as though it had been a direct quote.

  • I don't mean to sound contrite, but is this really surprising to anyone? Didn't anybody learn anything from 1929?

    Sorry I wasn't alive then. What was it like?

    The way I was taught to invest has been learned though listening to drunks at a bar, which now that I think about it, someone that drinks heavily from a major finicial lost probably doesn't give good advice on the stock market...

    Anyways, what I have always been told, is that you should invest for the long term, not none of these, dump a couple bucks in VALinux IPO and bail out early. (sure it works, but...). If you invest for the long haul, sure there is going to be up's & down's, but after 10 yeras, there will be a whole lot more up's than anything else. Invest in strong companies that will be here in ten years. A rule of thumb I was told was "Ask yourself, is this company going to be around in 100 years? Are they going to pull a profit every year (not matter how little of a profit)?"

    Look at GM, Coke-a-Cola, IBM, these are all strong companies, sure they aren't sexy start ups, sure they don't pull a billion dollars a day, but they will be there, and they will make money though the years. Tech companies can do this, but it wouldn't be as sexy now would it?
  • exhuberant" people probably use Windows, think that Microsoft makes great products, and wonder why the Department of Justice is persecuting such a great American success story.

    To be a little less flip, isn't a main point that a lot of people who don't know a heck of a lot about the technology they're investing in are doing so with a heck of a lot of money? Seems related to my first humor-impaired sentence, to me.

    The amount of margin purchasing bothers me WAY more. That should have been the ONE thing we learned from 1929, yet appears that we're heading back into the same track. By the way, 1929 was the last time the US Government ran a surplus, from what I've heard. We also had a president who said, "The business of America is doing business." The November election scares me.
  • Coca-Cola, 3M, and other old-economy companies do not have the huge growthrates that companies like Nortel and Nokia show.. Nortel grew revenues 48% this past first quarter. Compare that to Daimler-Chrysler, which grew revenues 17% in the first quarter. Both of these are huge companies, yet Nortel almost triples their growth rate.

    Agreed. However, growth comes at a very high cost, namely profitability. The primary purpose of any business is to make a profit. I think the bottom line is, don't panic, invest wisely, be patient, and diversify your holdings between risky companies that show little or now short term profit potential, and more stable companies that have historically shown a profit.

    And, if you stand to lose the baby's milk money in the market, you have no business being there.

    I agree with the author that much of today's investing is based on "emotion" and "herd mentality". Too many idiots throwing their life savings at the market in a purely speculative manner hoping to cash in on the next great dotcom. I think of the person I know who has a wife and kids, a new BMW and had to borrow $50K from his parents to cover his margin calls during the correction a few weeks ago. I shudder. Is this the "average" investor?

    A herd is eventually led to slaughter....

  • by The Man ( 684 ) on Monday May 08, 2000 @06:14AM (#1085773) Homepage
    Let's face it, it doesn't take a PhD in economics to recognize that a situation in which stock valuations have no relation to present or future earnings isn't going to be good. We've already seen a lot of air out of the tech market, but unfortunately it wasn't enough. Companies with no earnings and no prospects still have market caps in the 8 or 9 digit range... this is absurd. Others like Yahoo! have earnings but PE ratios well over 100.

    Ask yourself: if a heavy-equipment manufacturer had revenue, earnings, and growth identical to Yahoo!, would you pay $150 a share for it?

    Another problem that isn't mentioned in the text (though it may be in the book) is that there is way too much money in the form of pension funds and other public and private "forced" investment. This causes a localized inflation in equities markets as too many dollars chase too few viable investments. "Why would you buy Amazon???" "Gotta buy something..."

    So here it is, on the record and read-only: my target for the NASDAQ index bottom, whenever it's finally reached, is...2000. And I hope it kills all the idiot investors who seem attracted preferentially to unprofitable companies.

    Please, don't sue me if you use this for advice. In that case, you're an idiot as I have no qualifications.


  • There is little cause to worry.

    "ATTENTION, AMERICA! EVERYTHING IS JUST FINE! PLEASE STOP CARING AND START WATCHING HOURS UPON HOURS OF WWF WRESTLING! YOUR LEADERS WILL TAKE CARE OF YOU!"

    There *is* cause to worry, in fact there's a lot of them. We'll start with the easiest, which is the fact that the majority of the "safeguards", that you're referencing such as the Glass-Steagall Act of 1934 that made sure that banks and insurance companies stayed out of other markets, are being repealed left and right.

    I'm telling you, the people in power are going absolutely apeshit this time around, and if there is a crash, this time it's going to be *big*. And it's not going to have anything to do with economics, I would guess, since the ruling economic institutions have found themselves to be able to keep things seemingly good no matter what happens...

    No, if there's a crash, it will most likely be environmentally based. Think about the fact that we can eat over 30,000 different types of fruits and vegetables, but yet we focus on 30 specific types/strains? What about the fact that this group that we do rely on is becoming increasingly genetically modified, pesticide-ridden, irradiated, etc?

    What about the fact that the World Water Forum has concluded that the next World War will probably be fought over access to clean water? What about the fact that, despite this, they're looking to privatize water supplies (rivers, lakes, oceans, etc) anyways?

    The truth is that people and the environment are not governed by the rules of "the market", and either we can help destroy this economy of ours, or some horrid environmental issue will do it for us.

    Also, look here [salon.com] for a perspective on the corporate state.

    For how long are we going to watch people like Donald Fischer (The Gap CEO) exploit sweatshop labor and destroy old growth forests? How long can we let Monsanto have it's way with nature? How long will we allow the corporate press to wax ecstatic about an economy that's completely fake?

    How long will we buy their bullshit before we turn around, find ourselves a big stick, and clock these bastards upside the head?

    As for me? I hope for the land of do-as-you-please.


    Michael Chisari
    mchisari@usa.net
  • by Cally ( 10873 ) on Monday May 08, 2000 @06:06AM (#1085775) Homepage
    http://finance.yahoo.com/q?s=^IXIC&d=5y [yahoo.com] NASDAQ: five year chart
    http://finance.yahoo.com/q?s=^IXIC&d=1y [yahoo.com] NASDAQ: one year chart

    It certainly looks like a big correction could come any day now. Oh yes.
    Camaron de la Isla [flamenco-world.com] 'When I sing with pleasure, my

  • by Waav ( 33401 ) on Monday May 08, 2000 @05:45AM (#1085776)
    This looks really neat, and quite reasonable. I've been claiming for quite sometime now that the tech stocks are going to cause serious problems on the stock market in the very near future.

    I believe that this is a result of what Shiller refers to as herd mentality. The same phenomenon that has led to the insane IPOs is going to bring the market down. At some point some number of people are all going to bail on tech stocks at approximately the same time. The 'herd' who are trading from their home computer will nearly instantly begin selling their stocks.

    We've seen this happen already a few times in the last six months to differing degrees. I find it very likely that the biggest 'crash' is in the imminent future.
  • by MosesJones ( 55544 ) on Monday May 08, 2000 @05:51AM (#1085777) Homepage

    Look at the South Sea Bubble of 250 years ago for yet another example that

    a) Stockbrokers are like sheep
    b) people are greedy

    The market _relies_ on the sheep and herd mentality to get by. Economics is a psuedo-science that postulates theories that cannot be used. The Best Economics theory is by an ex-Head of the London School of Economics after the disasterous use of an economic theory by Margret Thatchers goverment... "Any economic theory that is used to determine policy shall cease to become valid". In other words folks it doesn't work at all.

    I laugh out loud when I hear of yet another wonder theory in the field of economics, remember Hedge Funds ? The great way to make a profit guarenteed.... didn't work did it ?

    The tech sector is a classic example of economists and brokers attempting to proscribe generalities to a broad sector. Most "reports" place Sun, Microsoft, IBM and Oracle in the same bag as Boo.com, etrade.com and various other .com only enterprises. There is NOTHING wrong with IBM et al, they are not bubble companies, they have relatively low P/E ratios and are solid as a rock.

    However when the market plunges expect them to take a hit. And when they do... buy them. Parts of the tech sector are over-valued, but not ALL of the tech sector is over-valued.
  • a provocative, even scary new book by Yale economist Robert J. Shiller -- is sending shock waves through Wall Street. Shiller argues that the techno-fueled stock-market boom is based on emotion, rumor, pyschology and herd instincts (like excitement about the Net), rather than on any rational facts or data -- and that it can't last.

    Duh. Most people realized this in 1999 and if they didn't then they would have after the dot com massacre of a few weeks ago. All it takes is one question to make people realize that the market is no longer fueled by hard facts but emotions and rumor.

    Q: Why does the fact that MSFT is being split up mean that the shares of Yahoo, Oracle, Red Hat, Amazon, Sun etc. should all fall 10 to 25 per cent?

    A: There is no logical reason that can be backed up by financial data or hard facts. But there are several emotional reasons why this could occur, chief of which is "If MSFT shares are falling then the shares of the stock I own will fall as well, I better sell.".

  • by Carnage4Life ( 106069 ) on Monday May 08, 2000 @06:35AM (#1085779) Homepage Journal
    Actually, there is a reason. The stock values of many of these firms is based heavily on the expectations of future earnings. The lesson of the Microsoft case is that if a company is too successful, it will be punished.

    FUD, FUD, FUD. Cisco (CSCO [yahoo.com]) is America's most valuable company and can be considered more successful and monopolistic than MSFT in every sense of the word. MSFT was punished not for being to successful or even for being a monopoly but for using it's success unfairly to damage competitors. Cisco (as well as Intel after making deals with the DOJ) is more successful than MSFT and is a technology company, yet it is not being harassed by the DOJ because "crush the competition by any means necessary" is not their guiding principle of operation.

  • by jayhawk88 ( 160512 ) <jayhawk88@gmail.com> on Monday May 08, 2000 @06:05AM (#1085780)
    My roommate likes to preach on about how the stock-market is going to crash hard, and usually I just ignore his rantings. However, two interesting items caught my eye in some magazine the other day:

    1. Buying stock on margin call's of 50% is now becoming common again. The last time margin calls were this high was right before the '29 crash.
    2. The number of individual investors has gone way up over the past 10 years, thanks in large part to internet and day trading. Again, this is what happened right before '29.

    My biggest fear about the stock market is not whether internet/technology stocks will go up or down, it's what happens to Joe Investor when they do. People who are not seasoned investors are now putting a significant portion of their money into stocks, internet or otherwise. What happens if tech stocks start to tank across the board? Old pro's will recognize this as a perhaps inevitable market correction. They may sell, or they may wait it out. Likely the experienced trader can afford to take a little hit to the bottom line, so they don't panic.

    Joe Ameritrade, on the otherhand, see's all his lovely $80/share stocks suddenly hovering around $20/share. Perhaps he panics, figures he'd better sell everything while he can, and starts to drive the price even lower. A major hit to tech stocks would start to affect other industries as well, dragging the entire market down.

    It's not hard for me to belive that a major, sustained downturn of internet/technology stocks would have a long-term, adverse affect on the market and our economy in general. We may not be talking 10 year depression, 30% unemployment, 30's style crises here, but for all of us dependent on information technology for jobs, times might be rough indeed. Brother, can you spare some bandwidth? Will code for food? ;)
  • The fact that the market is acting irrationally with respect to individual stocks should come as no surprise whatsoever to anyone who looked at the 3com palm valuations. The more important question is the technology sector as a whole overvalued.

    I think it was cringely who pointed out that a simple analysis suggests it is undervalued. Technology and internet sales should in the future account for a sizeable percent of all transactions. Therefore comparing against the total amount of sales in the US the total valuation of internet stocks isn't very large.

    The question at hand is then will the internet market be filled by a few big companies or many many small stores. If the former then the valuation for amazon.com and similar stores is not to high as they will probably control all of the internet market (the internet equivalent of GE or something). If on the other hand the low cost of entry into the market opens them up to little stores then they are tremendously overvalued.

    Fortunatly for them it does appear that the internet will come to be dominated by a few big companies in each area. Unlike conventional stores there are no underserved areas to strat a new company in. If I start a new brick and mortar store I automatically get a certain customer base of those people closer to my store than to the other. People may be dribing around and happen to stop in. The web on the other hand has no such features. If I happen to see another book store online it is no more trouble to click the bookmark for amazon then to enter this other store.

    Furthermore much more than conventional stores people wish to shop the same places online as there friends do. This is augmented by the efforts of these online stores to set up programs benifiting those whose friends are also members (gift lists etc..).

    As people seem to neglect price differences under a dollar or so the competition on the internet seems an unlikely force to draw people to seperate vendors. In fact the major vendors have a size advantage which is not compensated for by any sort of local advantage as every web vendor is an international seller.

    In truth it wouldn't be that surprising if one gnereal purpose retailer ended up serving 90% of the internet orders. As such the high internet prices can be viewed as a bet that this vendor is going to become the powerhouse or at least one of them.
  • by w3woody ( 44457 ) on Monday May 08, 2000 @07:36AM (#1085782) Homepage
    One: the market started increasing before the "net boom" started taking over the Nasdaq. Further, most net companies are invested on Nasdaq, not the Dow Jones. So while you can see the effect of the net boom by looking at the Nasdaq index verses the Dow Jones index, it doesn't explain fully why the Dow Jones has also been increasing in recent years.

    I will be the first to argue that there is a speculative bubble going on over the Internet. And I strongly suspect we're going to see a fairly large (20%? 30%?) correction on Nasdaq when that bubble pops.

    However, what most people who have been predicting a popping Internet bubble have forgotten is that a second thing is fueling the increase of the Dow Jones: lowered capital gains taxes has made it cheaper to invest in stocks.

    When capital gains were high, it was expensive to invest in stocks. Specifically, it was expensive to withdraw your money from a long-term investment and transfer it into another investment, or to withdraw the money and pocket it. In addition to income taxes, you were often hit up with a 30-35% capital gains. That means that if you were seeing a 10% rate of return, that the real rate of return was really 7%--better to put the money in a savings account where the return was maybe a point or two less, but guarenteed by banking insurance laws.

    When capital gains dropped, it made it more attractive to put money into stocks: now, the point spread between an insured savings account and a portfolio was much greater, and made the risk of losing your principle worth it--of course assuming a diversified portfolio.

    So when long term capital gains were cut in half, more people started putting their money into stocks. This made money on Wall Street "cheap", and increased the average P/E ratio of companies on the Dow Jones. And that drove the average up.

    Most people argued for a cut in capital gains because they wanted to see more money invested long term in our economy. What people forgot (and forget even now) is that when you do this, you don't grow the overall economy overnight--instead, you make it easier for companies to get capital. Hense, the increase in the Dow Jones.

    This is not "irrational exuberance"; this is a direct result of making it easier for established companies to raise capital in a capital market where money is cheaper to obtain. Expect this to collapse only if congress jacks capital gains up to 35%.

    Two: about technology "irrationality": we're already starting to see people figure this one out. A meeting I had with a Venture Capitalist (to help someone I know raise capital for his software development company) told me that he thought that many of the overhyped Internet stocks were incredibly silly, and he refuses to invest in new internet resalers.

    His rational was this: before the Internet, mail-order companies were fearcely competitive. The supply chain (that is, the chain of people between the manufacturer and the end consumer) in the United States was one of the most efficient in the world--in part because of a lack of entrenched monopolistic players or government regulations which causes supply chains in countries such as Japan to be enormously inefficient. And before the Internet took off, the supply chain was being made even more efficient--as were manufacturers--by such things as increased delivery efficiencies by players such as UPS or FedEx, as well as better stock management, stock prediction software, and "just in time" manufacturing and delivery of goods.

    The only two "inefficiencies" that existed in this supply chain is the 40%-60% markup at the retail outlet (which is required to maintain the store front as well as advertising), and for mail-order catalogs, the 15%-20% markup necessary to pay for advertising costs. And these aren't really inefficiencies: advertising costs are necessary as people who don't know about your product won't find it.

    So at best, the only places where you can squeeze cost savings out of the supply chain are in areas where competition amongst the various supply chain venders and other folks are really really good at it.

    At best, by computerizing the whole supply chain and fronting it with a web site to reduce advertising costs, the most you can hope to squeeze out of the process is perhaps one or two percent--a margin which makes the margins used by grocery stores seem absolutely outrageous.

    And many Internet business plans called for making a living on that 1 or 2%, including paying for extremely technically skilled experts, and paying for all this supply chain infrastructure that they said they were better at performing than people who have been doing it for 50 years.

    Already a number of Internet companies are backing off trying to make a living on creating more efficiencies, and emphasizing selection over price. For example, Amazon.com is really emphasizing the whole "best selection on earth" logo--in part because while their prices are good, they're not great: they do not factor in shipping and delivery costs which are traditionally part of the costs factored into buying books from a bookstore.

    How this will help the up and comming B2B web sites is beyond me--as these people are in essence saying they can make a living supplying what was originally the job of an MIS department over the web more efficiently, and skim the price differential.

    Yeah, right.

    This is what I'd call "irrational exhuberance."
  • by dsplat ( 73054 ) on Monday May 08, 2000 @05:49AM (#1085783)
    The market goes up and down. We refer to this as business cycles, booms and busts, or expansion and recession. The easiest bet to win is that the next recession will happen. This author at least has the guts to give reasons and work some numbers. But nothing about that prediction is revolutionary. And none of it should be any more alarming than the arrival of any previous recession. And that appears to be part of the message. We have not seen the end of business cycles. They are driven, in part, by human emotions: greed and fear. Technology is far from eliminating those.

    Personally, I look on the possibility of a serious correction in the markets as a buying opportunity. The secret is to find the companies that are fundamentally strong. Their stock prices will take a hit too. But they will come back, faster and stronger than the rest. If you are worried about whether good companies will be able to get funding, go find them and supply it yourself. Buy their stock. It could make both you and them rich and successful.
  • by rlk ( 1089 ) on Monday May 08, 2000 @06:32AM (#1085784)
    On the one hand, Shiller claims that the markets are being driven more by emotion than by any reasonable measure, and that it can't last. I agree with that. When even the most solid high tech/high growth firms are trading at multiples of 100 (price/earnings) and well-established bricks and mortar retail chains that cannot realistically expect high growth at 40, something seems out of line. Traditionally, conservative companies have traded at 10-15, and growth companies more like 20-30.

    I'm also concerned about a lot of other parallels with the late 1920's -- everyone's into playing the market, people talking about fundamental transformations of the economy, seemingly very low inflation in the price of material goods (as opposed to assets), increasing inequality, and such.

    But then Shiller recommends more of the same medicine -- expansion of the financial markets, "to allow people to protect themselves against major economic risks." In an irrational boom, this would only add fuel to the fire. Yes, the doctor in Des Moines could take a short position in medical incomes and in Des Moines real estate (which amounts to shorting against the box, a conservative way of locking in a profit). But is that what the doctor would really do? I doubt it.

    More likely, one of two things would happen:

    1) The doctor would go long on both positions, as a way of leveraging his income.

    2) Even if he shorted, the price of these securities would continue to rise in the short term, squeezing him (forcing him to cover his short position by buying the securities at a loss).

    The net effect is that our hypothetical doctor is more exposed, not less exposed, to risk.

    (There's also the little matter of what underlying assets these securities really represent. If they're merely trading instruments, with nothing backing them, then they're simply a form of betting and aren't hedging anything at all. Traditional options actually give the holder an option to purchase or sell a particular asset. Common stocks, while the connection is a bit more tenuous, do represent the ability of the issuing corporation to pay dividends, buy back its own stock, and otherwise benefit the shareholder. For this kind of scheme to work, a pool of doctors would have to pledge some fraction of their future income as ultimate payment on the security. That implies that they expect that income to be less than the price they write the option at. Uh huh.)

    We've seen the trouble that even sophisticated corporations specializing in financial services have gotten themselves into with derivative securities. Other companies have gotten themselves into trouble because they think they're hedging against some risk, where in fact they're doing nothing of the sort. And Shiller expects individuals to do better? If people systematically make mistakes -- and part of "irrational exuberance" is that people are consistently taking an overly optimistic view -- then there's a lot of potential for, shall we say, adverse consequences when things turn. Positive feedback (leveraging is a way of accomplishing this) is incredibly dangerous. It's even worse if people think they're hedging (applying negative feedback to their portfolios) when they're doing nothing of the sort.

    One of the things that fueled the crash in 1929 (whether it fueled the depression is another matter, but it's hard to see how it helped) was margin calls that led to what might be called a "death spiral". As the market dropped, people who bought stock on margin (with loans from their brokers) faced "margin calls" -- they had to pony up more cash because the value of the security was insufficient collateral for the loan. If they couldn't come up with the cash, they had to sell in order to raise the cash. The selling, of course, only drove prices down further, closing the feedback loop. Bad news. If the amount of the loans were less as a fraction of the value of the securities bought, there would be less risk of this because the market would have to fall further to trigger the margin calls that fueled the rout.

    I think that Shiller himself is a victim of the exact irrational exuberance he claims to be concerned about. He's right to be concerned about the insanity of the high tech (particularly the internet) sector right now, but I'm afraid that he simply wants to drain the craziness into everything else. Allowing people to leverage their future income is potentially disastrous. What happens if their future income is insufficient to cover their bet? Or, for the bear, if their counterparty can't cover? Then even the supposed hedge turns out worthless, and even the bear loses. That, I think, is even more dangerous than the current high tech boom.

    Call me a fuddy-duddy (at 36!), but I want to stay WELL away from that kind of nonsense.

"No matter where you go, there you are..." -- Buckaroo Banzai

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