Trains, Planes, & Dot Coms
As I sat down to write this edition of Perspectives on January 2, 2000, I thought about how much technology transformed the twentieth century. It is hard to believe that less than one hundred years ago, the landscape of America was rural. In the nineteenth century, America was unified by the technology of transportation. Railroads criss-crossed our continent, making travel between the east and west coasts a reality. The infrastructure was being laid, along with the tracks, for the US to begin the twentieth century as an emerging industrial giant. The railroad, the steam engine and the telegraph were setting the stage for transforming the country from an agrarian society to an industrial powerhouse.
The absence of governmental impediments and the endowments of our constitutional republic gave birth to a national character of self-reliance and a fierce spirit of independence. This gave rise to a strong entrepreneurial class and a "can do attitude" among the population. Unlike other nations, where class and privilege were entrenched, in America anyone with an idea and a dream was free to follow it. This spirit of independence and entrepreneurship helped to build the country's infrastructure in the nineteenth century and set in place the industrial and technological explosion that would take place in the following century.
All the tools needed for this expansion were here. Our country had sufficient natural resources for raw materials and energy sources for industrial production. What we lacked in money to finance the industrial revolution, we imported from overseas. America was becoming an economic power and quickly became a magnet for foreign investment. As the last century began, the country had everything going for it. Rockefeller supplied energy, JP Morgan provided financing, and Henry Ford and Alfred Sloan provided manufacturing and managerial expertise.
The American Century
As we began the twentieth century, the American spirit knew we would end as the world's leading industrial power. As we begin the twenty-first century, we have leap-frogged to become the giant technological power. In 1999, America dominated just about every category of technology: computers, software, communications, the internet and biotechnology to name only a few. We also dominated the newest form of leisure in the entertainment industry. American technology had transformed the country into a military superpower; unbeatable on the battlefield, with supremacy in the air and sea and a dominance in space.
"Everybody Ought To Be Rich"
Our industrial might, and now our technological prowess, have transformed our nation into the wealthiest country on the globe. That is why Washington pundits and Wall Street analysts are calling this a "new era" in American history. To prove their point, you only have to look at the stock market where wealth is being created at an unprecedented rate. Not since the 1920s has the stock market risen at double-digit rates for so many successive years. The nation has had seventeen fat years of non-stop prosperity. In the words of many economists, "The business cycle has been repealed." The predominant view of the country echoes the view of John J. Raskob, who in August 1929 declared, "Everybody ought to be rich!" Wall Street and the financial media of today sound similar to Raskob's peer, the prominent economist, Irving Fisher. Fisher, like Raskob, in the autumn of 1929 declared, "Stock prices have reached what looks like a permanently high plateau."
There's Nothing New Under The Sun
The truth of the matter is technological advances of the last decade are nothing new. The history of this country is a progression of nonstop technological advances. As exciting as the dot com companies of today and the advances of the Internet are, they parallel similar advances of an earlier age. This country has gone through five waves of technology advances during the twentieth century. We began with the railroad as the dominant industry. The railroad was supplanted by the automobile. After the automobile came the airplane. Similarly, we saw the emergence of the radio and then television. Television was followed by the computer and the electronics revolution. The computer produced the advancement of the Internet and along with it, the communications revolution which is now taking place. In the wise words of Solomon, "There is nothing new under the sun."
"The 'Mother of Invention' carries within itself its own demise."
In each new era, there is always the belief that the present trend will continue indefinitely. But there is a fallacy in this thinking. Technology is by its very nature self-destructive. Today's leading technology will be replaced by another technology. In transportation, the horse and covered wagon were replaced by the railroad. The railroad gave way to the automobile and the airplane. In communications, we've advanced from the telegraph to the telephone. We've gone from the radio, to the television, and now to the internet.
Each new era ushers in a new wave of "creative" destruction. Brought about by invention, survival of the fittest reigns as the order of the day. New technology is invented. If the technology survives, it creates a boom in products and companies that produce them. It also creates a cycle of financing and investing, which is manifested in the financial markets.
The Technology Cycle
The technology cycle begins with an invention. The new invention attracts the attention of visionaries who see its potential. But to survive, the technology must make its way to the mainstream economy. Unless the technology is adopted by the masses, it cannot long survive or it is likely to remain outside a niche market. The dustbins of technology are filled with wannabes such as the Edsel, Beta, and eight-track tapes. Even if a technology becomes dominant, not all companies that enter the field will survive. In the end, only a few companies that produce the technology will remain. The gorillas that survive may not even be those of the original inventor. The survivors are those who can best execute their business plan to become the best innovators, marketeers and low-cost producers.
To illustrate this point, where are the steam engines? How many automobile companies are left in the US? At its peak, the auto industry had close to over 2,000 carmakers. Today, the industry is dominated by only 3 carmakers. Of those three, only 2 are wholly American. An airline industry that once hosted over 100 companies, now has only a few. The computer industry that spawned hundreds of companies, is now getting down to just a handful. Today there are hundreds of Internet companies. In the next five years, it is doubtful whether many of them will remain. Just as in any new industry, Internet companies will consolidate and combine like other industries before it. In the end, only a few will survive and they will become the dominant gorillas.
Even if a technology survives, with a small and elite group of dominant companies competing, some new technology or medium will inevitably come along to compete or supplant it. For example, television and radio are still with us, but the companies that dominate the industry have to compete with alternatives. The three dominant television networks have ceased to remain independent. They have become subsidiaries of larger companies. We also see that the networks are losing market share. They must now compete with hundreds of cable stations as well as the emerging Internet real audio and video.
Technology, the "mother of invention," carries within itself the seeds of its own demise. It must constantly reinvent itself or it will not survive. For this reason, technology companies do not produce large dividends for their investors. Earnings and cash flow must be constantly reinvested in research and development to produce new ideas that improve or transform the technology. In the case of a mature technology, like the automobile that produces dividends during prosperous times, that dividend can be cut during economic downturns. In fact a major problem for today's auto industry is that too high a portion of earnings is paid out in dividends, rather than being reinvested in new technology. This is the main reason that the industry must constantly tap the capital markets for new money. It is also a reason that this industry's stocks sell for such low multiples in the financial markets. It has ceased to produce consistent and rising earnings. Therefore, its fortunes rise and fall with the economy.
Given the need to reinvent its future productivity, technology companies must constantly reinvest profits to produce new products or improve old ones. This becomes the cycle of growth that drives technological innovation. For those who invest in technology companies, finding the new technology and investing in the company that will dominate it, has become "the road to riches" during the twentieth century. We have also seen that there are times when investing in technology produced the loss of wealth and quickly led to poverty. Investing in a technology that is maturing or in technology at its market top, can just as quickly produce a story of "riches to rags." There have been long periods of time that cover a decade or more where investing in technological innovation produced poor results for investors in the last century.
Lean Years Always Follow Fat Years
After the stock market crash in 1929, the psychological nature of investors turned from euphoria to despair. The shock of the market losing 90% of its value and the subsequent loss of wealth that accompanied it, produced a negative cycle for investing that would take 25 years to recover. Despite the advancement of technology during this period, a depression in the economy and another World War produced results unfavorable to investing regardless of the technological advances that were taking place.
Everyone remembers the stock market crash and the Depression. What is forgotten is that a similar period of lean times occurred between 1964 and 1981. Even though our economy nearly quintupled, corporate profits advanced sixfold, and a countless array of new products and technology advances were introduced during this period, the market went nowhere. As Warren Buffet pointed out in a recent issue of Fortune, the Dow gained only one point from December 31, 1964 to December 31, 1981. Buffet said the country had experienced 17 lean years just as we have more recently experienced 17 fat years.
The 1990s became a decade of prosperity unparalleled in American economic history. The stock market, as represented by the Dow, rose almost fourfold. The arguments that this represents a new era for the country and the stock market are everywhere.
Technology investing has become the dominant form of wealth creation for the stock market. As the graph above exemplifies, the rise in the NASDAQ which is dominated by technology has been meteoric. The rise of technology stocks within the index has truly been parabolic in nature. In 1999 alone the Nasdaq rose over 85 percent! This feat has not been accomplished by any index within the twentieth century. This accomplishment pales to the performance of a few select technology stocks.
Chief among these select few is San Diego's Qualcomm. Qualcomm rose 1,882 percent in one year. After a spectacular rise during the first eleven months of the year, Qualcomm rose in an incomprehensible fashion in late December after a young analyst said the company stock would reach $1,000 a share within the next year. The analyst's pronouncement produced another rise of 50 percent within a week. The analyst predicted that Qualcomm's revenues would rise to $20 billion within a year. In his estimation, Qualcomm revenues will come from royalty fees of $5 per phone sold. In actuality, in order to reach these goals, 4 billion people [or roughly 50% of the world's population) would have to buy cell phones to reach that estimate!] Some say this is simply "fundamentals", others call it "speculation". I call it lunacy.
Not since the late 1920's and early 1970's have such a small handful of stocks produced such spectacular gains and so dominated the stock market. The justification, like the similar era that preceded this one, is that "It really is different this time." Technological advancement is unstoppable. Technology is truly transforming the economy and the world around us. The advancement of a narrow group of tech stocks is merely a reflection of this reality as a whole.
Rhyme and Reason for the Rise
Much of the rise and dominance of technology during this decade has had its roots in several causes that are unlikely to be repeated during the next decade. As I've pointed out in previous issues of Perspectives, the chief rise in the market, and in particular technology stocks, has more to do with Washington and the Fed, than it does a new era in technology. Yes, technology has continued to advance throughout this decade as it has throughout the twentieth century. What makes this past decade's advance so remarkable is the level at which stock prices have risen. The combination of the Fed's pumping the money presses, the concomitant rise in credit expansion and the subsequent lowering of interest rates, a relaxation of accounting standards along with creativity in accounting, combined with investors willingness to pay almost anything for earnings, has produced the euphoric markets we now enjoy.
Dot Coms & E-Traders
Technology has produced part of this bubble. The advent of the internet, e-trading, day-trading, financial networks and chat rooms have produced a price momentum market whereby tech stocks rise simply by their own price momentum. (See Perspectives Part 2 for a complete explanation of this phenomenon). Today's so-called tech investors are using technology to make their investment decisions, but may know little about the technology company they invest in.
It is a rare tech investor who knows about the company's product, the company's finances, or even the names of the company's officers. In today's tech-driven market, it doesn't matter. All that counts is a rising stock price. Corporate profits (if they exist), price-earnings ratios, price-to-growth ratios, and balance sheets are of little consequence. This has produced a Nasdaq that is selling at almost 200 times earnings and individual companies that are priced as high as 3,000 times earnings. For those companies that don't earn money, their price-to-sales ratio (assuming they have sales) are almost as ludicrous.
Feeding the Frenzy
In an effort to keep the myth of the new era alive, experts from Washington to Wall Street, to the media itself, keep feeding the stock market frenzy and the mania in tech stocks. The key to this game is money. The investment bankers have combined forces with the venture capitalists. In the words of one prominent investment banker, "The ducks are quacking: it's time to feed them." What is whetting the appetite of investors is as old as human nature itself. It is called Greed. The human desire to get rich quick or to get something for nothing has taken over. It is the gambler's desire to win big. This character decline is propelling the market to its lofty levels. The country is consumed by it and the investment maniacs that are driving it, will end up sacrificing their net worth; while industry insiders cash out.
In the final analysis, this technology mania will end. The process of self-destruction will reassert itself. The years of plenty will be followed by years of famine and the cycle will begin anew. Technology will continue to advance has it has over the last two centuries. New products will be invented, and new companies will be born. Another cycle of wealth creation will begin. But before the new cycle begins, an old cycle will end. That is the precise nature of technology.
Last fall, we saw Regis Philbin's "Who Wants to Be a Millionaire" sweep the ratings. Could this be who and what we've become?
Foresight in Hindsight
When this cycle comes to an end, many questions will need to be answered. How could stock prices rise so far, so fast? How could investors have been so willing to pay so much for what they knew so little about? Our leaders will need a scapegoat -- who will it be? Will it be Wall Street or will it be Washington? Whose face will they put on the tragedy? How will the media respond? Those "talking heads" in the media, who today so willingly proclaim the new era mantra, will change their tune. The new era accolades will be replaced by the sarcasm of hindsight. The hubris from the media will change to exaggerated calls for reform and regulation. But where have the regulators been throughout this bubble? It was only after the stock market had lost over 90% of its value in 1933, that Washington responded with reform legislation. By then it was too late. Will Washington guarantee today's Internet investor or day trader with a bailout?
When this technology bubble ends, and I'm sure it will, we will look back at this era with fond memories as "The Golden Days of Dot Coms." We will marvel at the technological advances even as they presently advance. We'll go on to praise and eulogize the era as easily as we condemn it. The era will have its villains and heroes. We'll remember the millionaires and the billionaires, as well as the rogues and the traders. In the end we will ask ourselves how we could have been so easily mislead. Was it the technology that mesmerized us or was it the fascination with wealth? In the end, I believe the answer is human nature itself. Our willingness to be mislead is blinded by the overwhelming power of human emotion. In prosperous times, we are blinded by a euphoria that produces greed and propels us to act irrationally. Just as in economic downturns, despair will overwhelm us with fear.
While Washington and Wall Street will look for answers to explain today's technology stock market bubble, they need look no further than human nature itself. The stage and the props may change, but the actors are the same -- man himself. I repeat the words of Solomon, "There is nothing new under the sun."
Perspectives Part 4 is a continuation of a series on the American stock market.
Each of these issues of Perspectives will tell a far different story than the one being portrayed on the evening news. In fact, these stories aren't being told at all. So stay tuned. This series will continue until the entire story is told.
Wisdom of Two Men From the Past Two Centuries:
George Santayana & Rudyard Kipling
George Santayana (1863–1952) is often quoted when we pause to reflect on our past and dream about our future. He said, "Those who cannot remember the past are condemned to repeat it." My hope is that investors of all shapes and sizes, with goals for college education, first home purchases, and retirement in their plans, will pause to reflect on where America has been in this past century. We've had our trials as well as our triumphs. To me, the most important aspect of the future in our investments is with an eye on our failures and the other on our successes. Somewhere in the middle is the balance we need to chart our investment course in the twenty-first century.
By Rudyard Kipling
If you can keep your head when all about you
Are losing theirs and blaming it on you,
If you can trust yourself when all men doubt you
But make allowance for their doubting too,
If you can wait and not be tired by waiting,
Or being lied about, don't deal in lies,
Or being hated, don't give way to hating,
And yet don't look too good, nor talk too wise:
If you can dream—and not make dreams your master,
If you can think—and not make thoughts your aim;
If you can meet with Triumph and Disaster
And treat those two imposters just the same;
If you can bear to hear the truth you've spoken
Twisted by knaves to make a trap for fools,
Or watch the things you gave your life to, broken,
And stoop and build 'em up with worn-out tools:
If you can make one heap of all your winnings
And risk it all on one turn of pitch-and-toss,
And lose, and start again at your beginnings
And never breathe a word about your loss;
If you can force your heart and nerve and sinew
To serve your turn long after they are gone,
And so hold on when there is nothing in you
Except the Will which says to them: "Hold on!"
If you can talk with crowds and keep your virtue,
Or walk with kings—nor lose the common touch,
If neither foes not loving friends can hurt you;
If all men count with you, but none too much,
If you can fill the unforgiving minute
With sixty seconds' worth of distance run,
Yours is the Earth and everything that's in it,
And—which is more—you'll be a Man, my son!