What's next for markets?

What Next for Markets? Psychology Holds Key Analysis: How much worse things will get depends on when fear is again overtaken by its counter-emotion, greed.

By TOM PETRUNO, Times Staff Writer

Many times in recent months, Federal Reserve Chairman Alan Greenspan has been asked if the U.S. stock market was a dangerous "bubble" at ever greater risk of bursting. His reply has been consistent: "I don't think we can know if there is a bubble . . . until after the fact," he repeated to a Senate panel Thursday. But amid the worst market decline since the 1987 crash, many Wall Street analysts, and individual investors, would argue that Greenspan was characteristically understating how he truly felt. Indeed, the spectacular run-up in the "new economy" sector of the market--primarily technology stocks--between October and early March looked like most of history's other great bubbles, all of which ended in massive investment losses for many of the players. It wasn't that the classic symptoms of a mania were missing; it was simply a case of both veteran and novice investors winking and nodding at those symptoms--and believing that either this time was different or that they could make it to the exit door quickly enough if the boom was about to bust. As Wall Street trading opens today after the 25.3% plunge last week in the tech stock-dominated Nasdaq composite index, the question on most investors' minds is "Where will it end?" But just as the winter run-up in hundreds of technology stocks took prices to heights few expected, the downside risk is equally unpredictable. It depends less on thoughtful investment discipline than on basic human psychology--when the fear now driving markets subsides enough for the opposite investing emotion, greed, to take over again. Greed, however cloaked in more polite terminology, is the driving force of every mania. As investors see others winning in the stock market or at some other money game, the desire to get in becomes overwhelming. Stock valuation rules that people held as sacrosanct just months earlier--how much a company should be worth in the market, for example--can quickly become compromised, or rationalized away. As Charles P. Kindleberger wrote in his 1978 book "Manias, Panics and Crashes: A History of Financial Crises," "As a boom progresses and greed mounts, excuses become thinner." In the Nasdaq market run-up, investors bid the prices of some unprofitable technology companies' stocks from the mid-teens to $200, $300, even $400 a share in a matter of months. Incyte Pharmaceuticals, a Palo Alto-based firm that provides services to biotechnology companies engaged in research into the human genetic code, saw its shares rocket from $19 in October to a peak of nearly $290 in February. There was, of course, some basis for optimism about the company's prospects, as excitement over human genome research was building among scientists and the public. Wall Street brokerage analysts, who generally are expected by their firms to present a bullish case for the companies they follow (or why bother following them?), helped stoke the market's fires by frequently raising their "price targets" for tech stocks as the shares surged. If the stock was at $100, an analyst might well present a case for $150 within, say, six to 12 months. But as shares of Incyte and many other tech firms rose ever higher, many of the individual and institutional investors behind that rise probably knew few facts about the companies' business, or how much the firms might eventually earn in bottom-line profit for the products and services they sell. Instead, Incyte, and so many other technology and "new economy" stocks, became "momentum" stocks: They were going up simply because they were going up. More troubling was that the purchases of many technology stocks in recent months were made with borrowed money, as investors, quite legally, took out a record sum in loans from their brokerages to buy as much stock as they could. Stock bought on credit will, of course, exaggerate an investor's gains as long as the share price continues to rise. But if the stock price begins to fall, the investor's losses likewise become exaggerated. What happened to shares of Incyte and other tech firms has happened many times before to stocks and other asset sectors in the United States and abroad. "Speculative excess, referred to concisely as a mania, and revulsion from such excess in the form of a crisis, crash or panic can be shown to be, if not inevitable, at least historically common," Kindleberger wrote. Usually, there is a fundamental optimism about the industry underpinning the price gains. But as buyers pour in, the asset's rise takes on a life of its own. Edward Kerschner, investment strategist at brokerage PaineWebber in New York, put it this way in explaining the surge in technology stocks: "While the benefits of the information revolution are for real, 'new metrics' [were] being indiscriminately applied to justify extremely high valuations for companies with no earnings and no well-defined path to ever reaching profitability." That same basic explanation has applied to virtually all recent, and even not-so-recent, investment manias: * In the early 1960s, a mini-mania occurred among, of all things, bowling equipment stocks. * In the late 1960s, many of the technology stocks of that era--names like Teledyne, Control Data and Optical Scanning--skyrocketed in what became known as the "go-go" era on Wall Street. * In 1979 and early '80, a modern gold rush ensued, as inflation-fearful investors bid the price of gold from $200 to more than $800 an ounce. * In Japan in 1988 and '89, that country's blue-chip stocks were viewed much as U.S. tech stocks have been viewed: too exciting not to buy, no matter how high-priced they appeared relative to their earnings or growth prospects. Each of those asset booms ended the same way: with a terrible bust. Share prices of Teledyne, Control Data and Optical Scanning all declined more than 80% from their peaks in 1968 to their lows in 1970. Gold crumbled from about $850 at its peak in January 1980 to about $400 by spring of that year. Japan's Nikkei stock index tumbled 39% in 1990 and today is still 50% below its all-time high reached Dec. 31, 1989. Already, many of the red-hot technology stocks that paced Nasdaq's winter surge have fallen far more than the average for the Nasdaq market as a whole. As of Friday, Incyte traded at about $75 a share, a 74% decline from its peak. But whether that is the bottom--or whether Incyte returns to being a $19 stock--is now anyone's guess. Why manias, panics and crashes generally follow the same essential script is no mystery to psychologists: Human nature doesn't change. Even people who should know better can be seduced by manias. And once panic ensues, raw fear takes over. More important than the direction of individual stocks, of course, is whether the market dive overall is capable of inflicting significant damage on the economy at large. Today in Asia, where economies have only begun to recover from the 1997-98 regional currency collapse, stock markets followed Wall Street's cue, plunging between 5% and 10%. A continuing decline in those markets could undermine confidence and threaten a fresh economic slowdown. As for the United States, Treasury Secretary Lawrence Summers on Sunday suggested that investors, as they ponder what to do with their stocks or with their cash, should remember that the economy "is in better shape than it has been in a long time." And certainly, the mania that gripped technology stocks in winter did not affect the vast majority of other U.S. stocks--many of which, in fact, have languished at prices that Wall Street pros have argued make them bargains. But bubbles, as they burst, have a way of causing damage far beyond their own shadows. That was the case in Japan, as the unraveling of blue-chip shares in 1990 and 1991 destroyed wealth and ravaged consumer and business confidence, making both sectors less willing or able to spend money. It was not the case in the United States after the 1987 market crash, however. The economy boomed in 1988 and 1989. What's clear today is that one entity that has in recent years been able to quickly restore positive psychology to markets will most likely not choose to do so any time soon. That is the Federal Reserve, with its control of short-term interest rates. While Chairman Greenspan has refrained from calling the U.S. market a bubble, he has used every opportunity to suggest that stocks' price gains were unsustainable--and that the Fed, which has raised rates five times since June, will continue to do so until it believes that markets, and the economy, are back in "balance."

-- Ken Decker (kcdecker@worldnet.att.net), April 17, 2000

Answers

CNN said the worst is over ,it's all uphill (gravy) . ASIA tonight to surge up , Mortal Lock!

-- justin (justlucky@aol.com), April 17, 2000.

Kenny the Roach's Ugly Mug here.

-- (No @ doubt about .it), April 17, 2000.

This is an excerpt from an recent interview with Robert Wilson conducted by Brett Fromson of TheStreet.com. As noted in the lead-in to the interview:

"Robert Wilson was one of the great stock investors of the past 50 years. He started with $15,000 and had a miserable rate of return in the early years. But from 1960 on, he turned $70,000 into $225 million over 26 years before retiring in 1986 at age 59. In his day, Wilson was a peer of Warren Buffett and George Soros."

Lin k

Fromson: ...Given that the public participation has never been greater than it is today, where do you think the individual has any kind of an edge? You're the little guy and ... how should they play it?

Wilson: In order to outperform the market, you've got to spend 18 hours a day on it. It's sort of incredible that you would not perform an operation on your wife when she gets appendicitis, but you'll play the stock market, and they both take almost comparable skills and comparable intensity and comparable attention spans.

The one thing you can do, the other thing you wouldn't dare do. So you're bound to get screwed. You are competing against people who are really working much harder at it, and probably have a special aptitude for it.

So it's not that the little guy is being victimized by the monopolistic forces of evil, he doesn't give it the time and attention that is required to even perform as well as the averages.

Fromson: So how then, can the little guy begin to educate himself or herself?

Wilson: Well, he can quit his job and work as an analyst at some major investment company, if he wants to make it a career, and even then the odds are against him. It's like tennis. It's a competitive game. To do better than the vast horde of people playing the game is very hard.

Fromson: Doesn't it then come down to who you choose to do your investing for you?

Wilson: Yes, it does. However, Brett, it is important to know that people like to gamble. They go to Vegas, they go, regrettably, to Atlantic City to gamble, and now to Indian reservations. There are certain people who just love to play around with the market, and people take some pin money and want to spend half an hour a day trading, God bless 'em. Just realize that they are going to be at a disadvantage like they are in Vegas or in any casino.

Fromson: Has the market always had these casino-like aspects in your mind, or do you think there was a time when it was more of a rational basis to stock prices?

Wilson: I think probably there was less rational basis. People didn't have the information they have now, there wasn't a) the required disclosure and b) the electronics. So I think people are much better informed now than they have ever been, so the quality of the market is better, but there have been these tulips.

Remember, we have been in a bull market since 1974, really, and if you've been making money for how many years is that?

Fromson: Twenty-six years.

Wilson: If you've been making money for 26 years, you really can't lose, can you?

Fromson: In what sense?

Wilson: I'm joking. I'm being facetious, if everybody, who has bought on weakness for 26 years has made money ...

Fromson: They're going to keep doing it. What do you think it would take to really break that kind of a psychology?

Wilson: Oh, a 50% drop in the Nasdaq.

Fromson: So, take the Nasdaq from say, 4500 down to 2700 ...

Wilson: And actually, it won't be 50%. It will be nearer to 70%, and maybe the whole market, the S&P will be down 40%, this used to happen, Brett, perhaps you're too young for this kind of thing, it used to happen every five years, five or six years. These numbers I'm giving you may shock your readers but it's run-of-the-mill for most market periods, the volatile end going down a lot in the averages. So Nasdaq down 70% and the overall market down 40%, 50% wouldn't be unheard of. And it wouldn't be the end of the world either.

Fromson: Yes, but what do you think it would do to a lot of the current people in the market who have never experienced that?

Wilson: Well, they would be in very bad shape because many of them who are in the market are really relying on the market to provide their nest eggs when they retire. A lot of people will be severely shaken.

Wilson: And of course they're not going to have, as you did, a short position, probably.

Wilson: If they did, they probably would have lost their nest egg already.

Fromson: So, what would you say to, if you had a nephew or a niece in his or her 20s or 30s and was coming and asking, Uncle Bob for some advice ...

Wilson: Right now I would say put it in bonds. I would say all of it, for now, yeah.

Fromson: Short-term bonds.

Wilson: Yeah, whatever, something that can't go down much, or up much. Just wait a while.

Fromson: And that's because primarily, because of the valuations, and at some point, something bad will happen, fundamentally, to the economy.

Wilson: And meanwhile, you could make -- this sounds derisory -- but you can make 6% interest. I don't know if municipal bonds, for somebody that young, is making a lot of money. Don't they yield 5%, 4%?

-- DeeEmBee (macbeth1@pacbell.net), April 17, 2000.

Ken,

Boy, is your title appropriate. I thought there might be a chance for a smooth glide down to realistic levels. But after watching all these idiots on TV this weekend saying how they were going to stay the course, I gave up.

At this juncture there will be no stopping a rise above 12,000 and a much further fall.

I honestly hope all the greedy bastards end up on welfare starving.

Todd

-- Todd Detzel (detzel@jps.net), April 17, 2000.

Hey Red -

Which one of your four cops gets to use bullets in his gun?

-- me again (@ .), April 17, 2000.

Ken,

Markets aside; those blondes look pretty attractive. How do you manage to get anything done?

-- Lover of blondes (hugginblondes@smooch.central), April 18, 2000.