Wall Street Journal: Bursting of the Tech Bubble Has a Familiar 'Pop' to It

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March 2, 2001

from wallstreetjournal.com (wsj.com)

Money & Investing Bursting of the Tech Bubble Has a Familiar 'Pop' to It By STEPHEN E. FRANK and E. S. BROWNING Staff Reporters of THE WALL STREET JOURNAL

It was a bubble, and it did burst. About that, most people agree.

What everyone really wants to know is, what's next? How much, and how fast, can technology stocks recover?

Investors trying to make sense of the dot-com debacle might do well to recall the story of William C. Durant. Early in the 20th century, Mr. Durant founded General Motors Corp., one of a revolutionary group of auto companies that in some ways were the dot-coms of their era. Investment capital poured in and GM stock soared more than 5,500% from 1914 to 1920.

But when the overcrowded automobile industry failed to deliver on inflated expectations in the early 1920s, auto stocks plunged. GM lost two-thirds of its stock value in six months. A panicked Mr. Durant borrowed money and feverishly bought the shares in a futile attempt to prop them up.

GM, of course, eventually recovered and soared again -- too late for its founder, who lost his entire fortune and wound up running a bowling alley. Many other once-great auto companies, such as Packard, Studebaker and Hudson, fared less well than GM, disappearing one by one in the ensuing decades.

And therein lies a cautionary tale for investors who have sat in shock as Cisco Systems Inc. stock has lost more than 70% of its value and Yahoo! Inc. shares have fallen close to 90%.

The current technology boom and bust, it turns out, is nothing new. It is simply the latest in a long history of investment bubbles that have plagued shareholders since investing began. From the Dutch tulip-bulb craze of the 17th century, to the locomotive revolution of the 19th, to the rise, fall and resurrection of personal-computer stocks and biotechnology stocks in the 1980s and 1990s, investors have fallen madly in love with -- and then madly out of love with -- the hot technology of the moment.

These past debacles offer lessons for investors trying to figure out what to do after the Nasdaq Composite Index's 57% fall from its peak last March 10 of 5048.62.

Bubble watchers say the worst may not be over. Just as the stocks tend to overshoot on the way up, bubble stocks tend to overshoot on the way down as well. Through Thursday, the Nasdaq index has lost 3.5% this week alone, and is below where it ended the year in 1998.

History does suggest that, eventually, many of the pieces of a burst stock bubble get patched back together. Some of the stocks will soar again. But the recovery typically takes longer than investors hope -- usually years, not months. Many of the stocks caught up in the bubble fail to survive, and of those that do survive, all but the most robust wind up behaving less exuberantly than they did before.

Question of the Day: At what level will the Nasdaq bottom out?

Technology companies "are going to take a good whack, a good hard landing, and you can't expect that they are just going to shrug it off and go up to new highs and forget it," warns George Roche, chairman of Baltimore mutual-fund group T. Rowe Price. "You are going to require a period to repair it."

Some optimists hope the recovery this time may come faster than it has after past bubbles. They point to the intervention of the Federal Reserve to stimulate the economy, and to today's pace of technological change, information flow and inventory adjustment, which is far faster than anything known in the past.

But even the most bullish observers aren't predicting an immediate snapback. In fact, a ghoulish fascination is developing among professional investors over the parallels between the current tech wreck and past stock disasters. Many of the pros have been sending one another charts overlaying an index of Internet stocks or the Nasdaq Composite against charts showing the biotechnology bubble that collapsed in 1992, the Dow Jones Industrial Average around 1929, or the 1990 collapse of Japan's Nikkei 225 Average.

The basic truth market historians draw from past bubbles is that it almost always takes longer to repair the damage than people expect.

After the economic crash of 1837, for example, it took a handful of railroad stocks a solid decade to regain precrash levels -- and most didn't. GM's recovery took six years, about the same period it took most personal-computer and biotech stocks to rebound in recent times. The Japanese stock market topped out at the end of 1989, and remains 67% below its peak.

Most recently, investors point to the 1992 biotechnology collapse. Biotech stocks, as measured by the American Stock Exchange Biotechnology Index, didn't stop falling until March 1995. They didn't regain old highs in a lasting way until December 1998.

There is also the fate of the electric utilities in the 1920s. Bearers of a breathtaking new technology that transformed the world just as the Internet is doing today, it was 1964 before they returned to their 1929 peak, and they never regained the vigor of their youth.

Radio Corp. of America was another highflier of the 1920s. America's fascination with the radio propelled RCA's shares to a high of $500 just before the '29 crash -- an increase of 2,000% over six years. The crash wiped out all those gains, and it took more than three decades for the stock to revisit its highs. Even then, RCA, which had become a television company, ultimately was undone by competition, and wound up being split up and sold.

Today's technology pessimists, such as Jeremy Grantham, co-founder and chief strategist at Boston money-management group Grantham, Mayo, Van Otterloo & Co., argue it could be a decade before technology stocks turn convincingly upward.

Mr. Grantham has tracked more than a dozen past bubbles involving gold, oil, nickel, the dollar, the British pound, Japanese stocks in the 1980s and U.S. stocks in the 1960s. In every case, he says, the stock, commodity or currency gave back all the extra, inflation-adjusted gains beyond what it would have attained if it had simply maintained its slower, prebubble performance. He believes tech stocks have still farther to fall, and that they will pull the broader market down into a lasting slump as well.

Not everyone's outlook is so bleak, of course. Henry Blodget, the Merrill Lynch Internet analyst whose name became synonymous with dot-com euphoria, says the worst of the downturn will be over by the latter half of this year. But even he believes complete recovery to last spring's highs could take as long as three to five years, even for some Internet bellwethers like Yahoo.

"I think we still have a ways to go in terms of working through the ripple effects of the bubble," Mr. Blodget says.

Another lesson from past bubbles is that, while some stocks such as General Motors do bounce back and soar again, it can be maddeningly difficult to figure out which will be the winners.

It is almost always a mistake to "catch a falling knife," as they say on Wall Street, which means to buy a plummeting stock. Even once-strong competitors can sag. Today, most investors would identify names such as Cisco, Sun Microsystems Inc., AOL Time Warner Inc. and eBay Inc. as leaders of the technology and Internet sectors. But those stocks all are down between 40% and 70% from their highs. Will they all recover?

Veteran money-manager Steven Leuthold, who heads Leuthold Group in Minneapolis, recalls his first electronics bubble, in which he lost some money in 1961 and 1962. The companies to own back then often had the syllable "tron" in their names, such as Transitron and Flowtronics. They aren't around today. "The lesson that you learn from all of these experiences is that they don't go on forever and there aren't very many survivors," Mr. Leuthold warns.

Consider the biotech stocks. A few, such as Amgen Inc., rebounded quickly from their 1992 collapse. But they were the exceptions. Other early stars, such as Xoma Inc., survived the debacle, but never returned to their peak prices.

"In biotech, there were numerous one-technology companies whose technologies didn't pan out," says Larry Feinberg, managing partner at Oracle Partners, a hedge fund in Greenwich, Conn. (which isn't related to software company Oracle Corp.). Something similar is true of many Internet companies. "The analogy, from a fundamental viewpoint, is that the industry has to be rationalized and developed," he says. "You get this wave of enthusiasm and then investors realize that they have shot too far in one direction."

Morgan Stanley software analyst Chuck Phillips has a name for this phenomenon: the "classic technology hype cycle." The cycle, as he describes it, has three phases: a "frenzy and land grab," followed by a slow maturation of the technology, during which the stock-market euphoria cools off, followed by "the production phase," when the real benefits of the technology kick in, a few clear winners emerge and the market gets excited again.

Many modern-day tech investors reassure themselves that tech companies will do better than past bubble victims, because today's companies are leading a wave of revolutionary change that will transform society for years to come. Sadly, one of the most painful lessons of the past is that bubble companies often are involved in a revolutionary technology. That doesn't prevent their stocks from crumbling once they get pushed up too far.

Visionary technologies and ideas have been coming and going for centuries, in fact, leaving stock disasters in their wake. In the 18th century, the promise of foreign trade excited Britain. An outfit called the South Sea Co., given a monopoly on trade with the Spanish Empire, soared on London's stock market. Trade eventually did make fortunes for some people, but not for the South Sea Co., which became a disaster dubbed the South Sea Bubble and helped throw the British economy into a slump.

After Charles Lindbergh piloted the Spirit of St. Louis across the Atlantic in 1927, proving trans-Atlantic flight was possible, airline stocks took off. Few survived. One company that saw its stock soar, Seaboard Air Lines, was in reality a poetically named railroad.

So, too, today. Though his company is expected to post sales of around $3.5 billion this year, Amazon.com Inc. founder Jeff Bezos frequently has warned investors that it isn't yet a lasting company -- and may never become one. "The track record of innovators is not good," he has said.

He is right. Visionaries aren't always good managers, and the much-heralded "first movers" can lose out to companies that get the kinks out of great ideas.

Look at what happened to the creators of modern database software in the late 1980s. A host of start-ups went public -- with names like Informix Corp., Ingres, Oracle Corp. and Sybase Inc. -- promising to change the way information is stored. Their products allowed customers to find and manipulate data easily, using plain English commands. Orders rolled in and the stocks soared. But the software, riddled with bugs, began crashing, and so did the software makers' stocks.

By 1991, Oracle was losing money. Its shares plunged to single digits, shaving more than 80% off the nearly $4 billion market value it had as of mid-1990. The company was forced to take on an $80 million loan from Nippon Steel Corp. because no bank would lend it money. Oracle survived, in part because it brought in additional managers to help implement founder Lawrence Ellison's vision. A decade later, Oracle's market value is north of $105 billion.

And Oracle's rivals? Informix and Sybase today have market values of less than $2 billion each. Ingres was acquired by Computer Associates International Inc. in 1994 for about $300 million. Since the intervening decade, of about 2,000 other software firms that went public, just 417 exist as independent companies. The rest either were acquired or went out of business.

There are some reasons to hope that a tech-stock recovery may happen faster than has been the case after past bubbles. Apart from the government riding to the rescue with interest-rate cuts and a possible tax cut, a more fundamental reason for hope is that technology's life cycle is shortening. That means equipment is becoming outdated far faster than in years past. Like it or not, companies that want to keep up with changing markets have no choice but to buy new gear all the time.

An example is Intel Corp., the world's leading chip maker. Though chip demand has dropped off, Intel plans to spend $7.5 billion this year on new manufacturing equipment, an increase of about $1 billion over last year. Intel has the equipment to produce chips with very high processing capacity, but those technologies are rapidly becoming stale. Intel's latest-generation Pentium IV chip is built to operate best at an even higher processing capacity, and that requires expensive new equipment. In another four or five years, on average, that new manufacturing equipment, too, will become outdated.

Contrast that with the 1920s, which witnessed revolutions in transportation, telecommunications and manufacturing. Unlike today's equipment, with a lifespan of just a few years in some cases, manufacturing plants constructed during the 1920s were supposed to last for decades.

"With information technology, you can make huge investments now, but basically three years from now it's depreciated to almost nothing," says Peter Garber, a global strategist at Deutsche Bank and a professor of economics at Brown University. "Because of innovations in hardware and innovations in software, information technology just evaporates."

So tech companies will continue selling gear, perhaps at a faster rate than utilities sold electricity and PC makers sold computers when their stocks were declining. What no one knows is whether the demand will be strong enough to make today's tech stocks start to rebound sooner than those of yesterday.

"Things happen quickly today, so it wouldn't amaze me if it [a recovery] happened in two or three years," says Mr. Grantham of Grantham Mayo. Still, he adds, "history says that the great bear markets take their time.


-- Carl Jenkins (somewherepress@aol.com), March 02, 2001

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