From 1995 till the spring of 2000, the US stock markets went on an unprecedented run upward. It was nearly impossible to lose money in any stock, and many investors confused a bull market with their own investing genius. Tremendous paper wealth was created, and a new “equity” culture came into being.
I should have known better when I saw that the firemen stopping in the ER were routinely checking stock prices on the computer. There is the old story of how Joe Kennedy, the patriarch of the Kennedy clan, and father of John, Edward, and Bobby, sidestepped the stock market crash of 1929. Supposedly, he moved all his money into cash after being alarmed by the fact that a shoeshine boy was telling him what stocks to invest in. When everyone is in the market, then it can’t go any higher as there is no new buyer to push prices up.
At its giddy height, the broad market index of the 500 largest American companies had tripled in value from early 1995, and the Nasdaq tech sector had surged over 6 times. Some of this gain was in fact warranted, but a fair amount, especially in technology, was not. Even after a 60% drop in Nasdaq and a 25% drop in the S&P 500, stocks still show substantial gains from 1995.
The broad currents pushing the market upward included a sharp rise in corporate profits, a surge in worker productivity, and a decline in interest rates. In addition, favorable political events, low oil prices, the longest peacetime expansion in history (still ongoing, but much subdued), and the rollout of new information technology made stocks extremely attractive. Workers were also encouraged to enter the stock market as employers increasingly switched their workforces into 401(k) schemes rather than traditional pensions. 401(k) and IRA money flooded into the market.
All of these factors would have ensured a healthy and rising market in the last five years, but what drove things through the roof was the Internet mania. The dot-com boom created a new set of companies that were given huge market valuations when they had no profits, and even more troubling, little actual sales. As these stocks took off, other more traditional tech stocks that were quite profitable such as Microsoft, Oracle, Intel, and Cisco, got pulled upward too. Their valuations reached levels never before seen for large companies. Traditional companies commanded stock prices that were 10 to 20 times their profits, but these companies changed hands at 50 to 100 times profit. As the saying went from an earlier bubble, these stock prices were not just discounting tomorrow, but also the hereafter. At its peak, Cisco’s stock was worth more than all the car companies in the world combined. Yahoo was worth more than all the newspapers of America combined.
But in the summer of 2000, all these trends changed rapidly in the other direction. Interest rates were being pushed up. Economic growth slowed sharply. The dot-coms started to run out of money and go belly-up. The Internet bubble collapsed, viciously and in a hurry. What seemed so sensible six months now was clearly the height of folly. Oil prices rose, and energy disruptions threatened the largest state in the Union, with rolling blackouts in California. Investors rushing for the exits found few willing buyers, and stocks dropped like a rock. Intel went from 75 to 27. Cisco plunged from 80 to 15. Oracle also dropped from 80 to the teens. Most dot-coms fell into bankruptcy or penny stock territory. The biggest dot-com of them all, Amazon, is surviving off cash it raised in 1999, but Wall Street is suspicious of its long term outlook. Jeff Bezos, the CEO and founder of Amazon, was Time Man of the Year in 1999, a choice that seems rather humorous now.
Going forward, the future looks murky. Greenspan has slashed short-term interest rates repeatedly since January, but he has not been able to revive the economy or the market as of yet. Greenspan’s moves will eventually succeed, but more so with the economy than with stocks. The reason for that is that stock prices are still too high. Usually after a period like the last 16 months, the markets fall to 10-15 times earnings, giving some room for price move upward as earnings grow. But even with the sharp pullback, many stocks still sell for very high multiples. Cisco is still at 40 times earnings, as is Microsoft. Intel is trading at least 30 times earning. Even non-tech is pretty pricey. This includes biotech and drug stocks, as well as financials and energy. With these valuations, stock investors probably can expect no more than 8-10% gains in the next 12 months, which is not too shabby, but disappointing for those who got used to the late 1990’s.