Wall Street and Main Street Come Together
We look backwards in order to see ahead.
Not that history repeats itself neatly or rhythmically. But human folly is episodic. It comes and goes — sometimes comically… sometimes tragically.
Since markets reflect human folly, it is possible to understand them as recurring patterns of foolishness. If you want to know what damn fool thing a man will do next, in other words, you merely have to look and see what he did last.
I noticed, for example, in a popular internet message that is making the rounds, that there appear to be far more crooks, spouse abusers, deadbeats and bankrupts in Congress than random chance would permit. The bounders are drawn to Washington just as Willie Sutton was drawn to banks. And it wouldn’t take a soothsayer to predict what kind of mischief they would get into there. The crooks will rob us. The deadbeats will cheat us. And the abusers will batter us. The others will just bore us to death.
Investors, meanwhile, will run prices up to absurd levels in the vain hope of getting rich without working. Then, the prices will come down and investors will get what they deserve.
None of this will be as obvious or as predictable as the villainy and perversion in the Capitol building. Sometimes, we have to look far back into the history of markets to see the aberrations. Even then, they are often exasperatingly persistent.
One of the curiosities of the present boom is the way in which Wall Street has taken leave of Main Street. This is not merely the alienation of the old economy from the new, but of the economy itself from its source of capital. It is as if Lower Manhattan has become a fantasy island… drifting off the coast near Boca Raton.
Juniper Networks went public a few days ago. If you’d invested in it on the opening and held until the end of the day you would have lost 7.5% of your money.
But the privileged guys who got in on the IPO placement did much better. They made a profit of 329%.
Not bad? Even better off were the venture capital investors — who paid $8.3 million for shares in the business, now worth $1.58 to the public. They made a profit of 18,918%. Naturally, everyone now wants to be a venture capitalist.
And nearly everyone is. Wall Street has been happy to shift the risk of funding internet start-ups to the public. The internet sector now has a $1 trillion market value. That represents, overwhelmingly, companies without a history or profits… and no real evidence that they will ever be profitable.
In short, they are venture capital-level businesses — the kind of businesses that wouldn’t have been able to get to the public markets at all a few years ago. What is happening is that Wall Street has out-sourced the underwriting risks of new ventures to ordinary investors.
“Right now,” says internet investment maven Mary Meeker in Barrons, “companies are going public at the equivalent of the first round of venture-capital funding three to five years ago.”
The public thinks it is buying stocks. Perhaps it is. But they are not the same quality of stocks that Wall Street has traditionally offered. Instead, they are more like the paper issued in Vancouver… Denver… or Alberta. They make the promoters a lot of money. They can even make investors some money — for a while. But rarely, if ever, can these speculative shares be bought at high prices, held for more than a few months, and sold at a profit.
I have a friend in Baltimore who is one of the country’s shrewdest venture capitalists. He does not buy stocks. He buys into companies at an early stage, gets to know the management, offers business advice as well as capital… and sticks with the company until it is mature enough to take to the public. That used to be a process that took years to accomplish. Now it can be done in the time between breakfast and lunch.
My friend is a real pro — with a team of professionals behind him. He is capable of assessing the risks and opportunities of venture capital investing. He will take months or years investigating a company before he decides to invest. Even then, most of them do not work out.
This is no business for amateurs. And yet, it has been turned over to amateur investors — who pick up good deals, bad deals, and terrible deals — whatever Wall Street sends their way. The venture capitalists pocket the loot and race to get out a new IPO before the spell is broken.
The gap between Wall Street and Main Street can be measured, crudely, by the profit margins of the venture capitalists. They make their money by nurturing a private business — or something that aspires to be a business — and selling it to the public.
You could also gain a measure of the canyon between Wall Street and Main Street by aiming your transit at the difference in prices for private businesses as opposed to public ones. Private businesses still sell for about 5 to 10 times earnings. But the S&P sells for an estimated 200 times earnings.
This gap between Wall Street and Main Street… between the public markets and the private ones… is an aberration that is not likely to persist forever. If you can make an 18,000 percent profit taking little companies without earnings to the public markets — you can bet that a lot of people will do so. It won’t be too long before the supply of goof-ball companies, with no earnings and not much hope of every having them, exceeds the available supply of foolish money. Then, the whole thing implodes. The money that people think they have doesn’t go into other investments — it just disappears.
Another way of looking at the gap between the financial markets and the real economy is to look at the relationship of stock trading to GDP. Dollar Trading Volume in stocks completed 1999 at 200% of GDP. For every dollar spent on food, clothing, housing — whatever — in the real economy, investors spent $2 on stocks.
Yahoo shares, alone, on a single day of trading in December, were equivalent to 86% of that day’s GDP. As Alan Newman, who provided these numbers, put it: “Never before in history have stocks been this important.”
From 1930 to 1980 the volume of stock trading was less than 25% of GDP.
In the first few trading days of this year, the gap closed a little. Stock prices fell. And the most absurd prices fell the most. I predict that this trend will continue. Exactly what kind of tectonic shifts or financial storms will occur, I don’t know. But I would bet that 10 years from now, Main Street and Wall Street will be closer together. Best wishes.
Paris, France January 6, 2000
*** One Daily Reckoning reader confessed that he used me as a counter-indicator. He bought when I said sell… and was doing quite well, he said.
*** Warning: even as a counter-indicator, I may be unreliable. The dollar has slipped about 3% against the euro since I advised selling it a couple of days ago. And Amazon dropped 15% of its value yesterday alone — a day after I said it was doomed.
*** “Life can only be understood backwards, but it must be lived forward,” said existentialist philosopher Kierkegaard. The best you can do is to try to spot the historic aberrations and guess about when they might regress to the mean. The market’s role is to humble us… after first letting us think we are geniuses.
*** The Dow bounced back a bit — up 124 points yesterday.
*** But, Houston… we may have a problem. The internets — the Rocket Chips of the New Era — sputtered dangerously. Has anyone checked the O rings?
*** Amazon fell when the company admitted that even 4 times as many sales as the previous year had failed to bring the company closer to profitability. Yahoo went down 7%.
*** Meanwhile, the old economy stocks led the return of the Dow. Energy, utility and natural resource stocks — generally — did okay.
*** Remember my prediction — in the years to come, these old economy stocks will do better than those of the new economy.
*** How about Philip Morris yielding 8.3%? Or General Motors… with a p/e of less than 9? These Dogs of the Dow might have a bark or two left in them.
*** Or how about the builders? Personal Finance recently spotlighted a handful of them. Earnings per share were growing at rates between 13% and 18% and they are trading at P/Es of 5.5 to 7.5.
*** Of course, in a recession, the homebuilders will not do well. January will mark the 107th month without a recession — a new record. This, too, is an aberration.
*** Personal Finance is edited by Stephen Leeb, who has a new book out. I have not read it, but the review says he “presents overwhelming evidence that [technological] progress is actually slowing.” Hmmm… What kind of New Era is this?
*** A strange one. Swaziland’s parliamentary speaker has been asked to resign after he was found taking cow dung from the royal enclosure. People feared he might be using it for some nasty ritual.
*** Microsoft’s capitalization approaches the value of the entire US Treasury Bond market. All the bonds issued by the Treasury with a maturity, at origination, of greater than 10 years have a combined value of about $650 billion. MSFT’s capital value is over $600 billion, too.
*** I used the word “fraud” to describe promises of Wall Street. I worried that it might be too strong a word. But here’s Alan Newman’s comment: “Momentum ‘investing’ has caused the capitalization weighted indexes to become frauds.” And “the major markets are perpetuating a fraud by suggesting that most stocks are in a bull market.”
*** The Nasdaq 100, for example, “is adjusted daily,” he writes, and “has resulted in a situation where the most rapidly appreciating stocks have the greatest influence on the index — it is now easier for the index to rise and more difficult for it to fall.”
*** Despite the indexes, 54.2% of all stocks in the US were down in price last year. The bull market, says Newman, is a “new era fantasy.”
*** Newman’s Crosscurrents website is a wealth of information. He shows, for example, that the “zero years” — such as 1980, 1990 and so forth — are bad years for stocks. Since 1890, they’ve averaged a 7% loss in stock prices. I note that we have not had a year with so many zeros since Paris was a village and Manhattan a wilderness.
*** Jules went to see The Sixth Sense yesterday. He had nightmares about that too.