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Technology Stocks : Wind River going up, up, up! -- Ignore unavailable to you. Want to Upgrade?

To: chic_hearne who wrote (9354)	3/26/2001 3:03:43 PM
From: Allen Benn	Read Replies (1) \| Respond to of 10309

Are you aware that the total market value in 1929 was 70% of GDP? Are you aware that the total market value of Japan in 1989 was 130% of GDP? Are you aware that the total market value in March of 2000 was well over 200% GDP? This seems to implies the U.S. stock market hit historically extreme levels by 2000, with an inevitable crash of equally historical proportions. Sounds neat, and it is very much in keeping with Schiller’s “Irrational Exuberance” – based on historical comparisons. It also is probably dead wrong. A compelling economic case can be made that the U.S. stock market was significantly undervalued at the start of 2000. Now, don’t get me wrong. I was constantly critical of the dot-com fantasy and the market’s love affair with large tech caps – a frequent subject on this thread. The Linux stock fad was especially maddening, and frightening (RHAT could have taken out WIND for chump change during their height of market popularity). But these internal market stupidities do not make the case that the U.S. stock market was ever overvalued. Nor do they imply that even most tech stocks were overvalued. Let’s dig deeper. Be very careful of historical observations in a young, evolving global stock market. Civilized society has been producing and engaging in commerce for thousands of years, yet stock markets are relatively new to the world of commerce. The most powerful stock market of all, the NYSE, is not quite 200 years old; the NASDAQ is only about 30 years of age. Even by the early 1900’s, few people owned stocks or cared much about the stock market. A clear trend over all those years is that more and more of the production and services of the U.S. is monitized through equities. Wall Street has an endless capacity to suck industries, services and financial instruments of all kinds into the stock market. I don’t know, but I strongly suspect the percentage of industrial capacity, agriculture and services, financial and other, that is securitzed has grown steadily over the entire history of the U.S. stock market. This growth alone could account for much of the increase in the portion of GDP accounted for by the stock market. But there is more. The ratio of the U.S. stock market to GDP is the macroeconomic extension of the Price to Sales ratio of individual stocks – for the securitized share of the economy. In other words, the contention that U.S. stocks were overvalued because they represented 200% of GDP is identical to saying the Price to Sales ratio of the average stock was excessive in 2000, by whatever factor you would like to see the 200% reduced (determined after accounting for the growing presence of public companies.) To make this claim, let’s look more carefully at the P/S ratio. The following equation is an identity: P/S = Net Profit Ratio* P/E In words, the Price to Sales ratio of any stock is precisely the same as the Net Profit Ratio times the stock’s Price Earnings ratio. Thus, there are two reasons why P/S might appear excessive. One of them simply may be that average profit levels of stocks might be in a secular uptrend. Profits undeniably were in a cyclical uptrend over the last five years at least. The other reason, P/E ratios, reflects anticipated future growth. Indeed, P/E ratios are extremely sensitive to changes in anticipated growth, especially in a low-interest environment. While it may seem obvious in hindsight to claim P/E ratios were excessive, you may still be wrong. To the extent that there is a new, digital economy, with network economies of scale, anticipated growth in a richer, global economy may be higher now than ever before. Certainly, the Congressional Budget Office seems to think highly of U.S. prospects for enhanced growth over the coming decade. As an asset class, stocks have consistently outperformed bonds over long periods of time without a consequent risk penalty. This market inefficiency is known as the “equity premium” and leads to the compelling argument alluded to above that the market is undervalued. Glassman calculated that to account properly for the risk-adjusted equity premium difference between stocks and bonds, the DOW should be at 36,000. I can’t defend his calculations, but the very existence of an equity premium implies P/E’s, if anything, are too low, now and in all of 2000. Thus, the growing percentage of U.S. GDP represented by the stock market capitalization simply may reflect the increasing penetration of equities in all aspects of the economy, secular increases in corporate profits, anticipated profits in the new digital economy, and the inevitable elimination of the equity premium. All markets correct, irrespective of whether they are overvalued or undervalued in some intrinsic economic sense. The fact that 2000 was bad for stocks was, in my mind, unpredictable but not surprising. What was surprising is that stock prices didn’t simply correct, they suffered a 100-year crash. Valuation per se had little to do with a crash of such magnitude. History teaches us only governmental blunders can destroy so much wealth so fast. Allen