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To: BGR who wrote (12514)	2/24/2000 2:34:00 PM
From: MythMan	Read Replies (2) \| Respond to of 42523

>>If, indeed, a handful of technology stocks are pulling up the indices << You don't realize that is the case?

To: BGR who wrote (12514)	2/27/2000 1:23:00 AM
From: Oblomov	Read Replies (1) \| Respond to of 42523

If, indeed, a handful of technology stocks are pulling up the indices, then you cannot blame index fund investors for that. They buy the whole index - BGR, I am not blaming the investors. I am pointing to the indexing phenomenon as a reason for the narrowing. There are other reasons as well, but I do think that it exacerbates the fact that capital is being allocated to a smaller and smaller group of companies. Let me create a hypothetical index of three stocks: A, B, and C. Let A be 40% of the index, B be 35%, and C be 25%. Obviously, new capital will be allocated in this proportion as well. As the market begins to top out, the weaker stocks will cease to rally. And although the index is still rising, the weaker stocks are falling, and are thus becoming a smaller proportion of the index. So, over time, the proportions would change: A B C --- --- --- 40% 35% 25% 39% 36% 25% (A starts to weaken) 38% 37% 25% 36% 38% 26% 34% 36% 30% (B starts to weaken) 33% 35% 32% 32% 33% 35% 30% 31% 39% 28% 29% 43% The capital inflow allocated to the stocks that are weakening shrinks over time, and so there is less capital inflow to support the price. If the total market cap of the index is not rising faster than the rate at which the proportions of A and B are shrinking in the index, the prices of A and B must therefore fall. Assuming the total market cap stays constant in this example, over the whole period, A would have fallen by 30%, B would have fallen by 17%, and C would have risen by 72%. The trend in each stock would have been reinforced by indexing phenomena. The R2K is an example of this phenomenon. Less than 200 stocks (mostly tech and biotech) are letting it continue its advance. IMO, the old-economy/new-economy dichotomy is false. The fact that the idea is expressed in catchphrase formulation should be suspect enough to discredit it. All modern companies rely on technology to some degree. The fact that an Amazon.com or Yahoo! or Go2Net use the Internet as their medium does not make them technology companies. The hardware and software manufacturers are not all growing rapidly, as the stock performance of MSFT and DELL indicate. Next, risk premia are dependent on future performance. You are claiming that your crystal ball is more accurate than the markets. Well, you know that such subjective claims may not be debated. I don't claim to have a crystal ball. But the market culture has grown increasingly speculative. Many people who are buying the hot stocks are doing so only because the stocks are hot. A gross lack of understanding of risk, not to mention investing, is prevalent. The EMH is an extension of the theory of rational expectations. But, if the local behavior is irrational, does the global behavior necessarily "cancel out" the irrationality to produce a rational global result? I believe not. Normative behavior is "reasonable" behavior, which is not necessarily the same as rational behavior. The level of consumer and corporate debt implies that there is little concern about downside risk in the economy. Well, let's hope that that is true, because little downside could be tolerated. This said, my models are an attempt to quantify risk, not predict market direction. I'll leave that to the other people on the thread. -g- Andrew