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If Pets.com’s IPO and failure in 2000 epitomizes internet excess, investors in the future might look back in wonder at the willingness of today’s investors to justify lending money to highly indebted governments. PHOTO: BOB RIHA/LIAISON/GETTY IMAGES
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BY: JAMES MACKINTOSH
Updated Aug. 15, 2016 10:26 a.m. ET
The stock market is partying like it’s 1999, and for exactly the opposite reason. Last week the S&P 500, Dow Jones Industrial Average and Nasdaq Composite hit a synchronized high for the first time since the eve of the millennium. America’s most valuable company is a tech stock (Apple today, Microsoft back then). The tech sector is back above a fifth of S&P 500 market capitalization, and just as then bears worry that the market is overvalued, although not by anywhere near as much.
In 1999, wild optimism was elevating the market as investors piled into anything with “.com” after its name—leading to a rash of stock-price-boosting name changes. Investors punished dividend payers for not having enough ways to spend money on transformative tech. The number of clicks beat cash flow as an investment tool.
The contrary is true this year. Wild pessimism about the global economy has led investors to chase dividend payments, demand buybacks and punish companies that invest. Cash is king.
And yet, the market rises. “Nobody seems to be particularly optimistic about much of anything and yet the stock market in the U.S. seems to do nothing but go up,” said Ben Inker, co-head of asset allocation at Boston fund manager GMO.
The theoretical justification for higher prices now, as it was then, comes from the dividend discount model. This states that the value of a stock is the total of all future dividends, discounted back into today’s money. The bubble mentality of the dot-com era made earnings forecasts all but redundant, but the hope was for big profits one day, which eventually translate into dividends to justify the price.
Something radically different is under way at the moment. Pessimism has depressed bond yields, reducing the discount rate and so making even fairly stagnant future profits look more attractive in today’s money. Higher prices are justified, without needing much in the way of earnings growth.
Prof. Robert Shiller of Yale, joint winner of the economics Nobel in 2013, calls this the “new normal bubble.” “Paradoxically when people are most pessimistic about their own future, stock prices are at their highest,” he said. Worried households save more, pressuring the economy and leading to lower interest rates—so boosting shares.
Finance theory hasn’t exactly covered itself in glory over the past couple of decades, and this analysis comes with a snag. Just as expectations of future profits from the first wave of dot-coms proved horribly wrong, so expectations that central banks will keep rates low pretty much forever might also prove mistaken.
If Pets.com’s IPO and failure in 2000 epitomizes internet excess, investors in the future might look back in wonder at the willingness of today’s investors to justify lending money to highly indebted governments.
“Negative rates to me make no sense,” said Leon Cooperman, chairman and chief executive of New York hedge fund Omega Advisors. Euphoria in the stock market in 1999 has been replaced by euphoria in fixed income in 2016.
This lament isn’t exactly new, with frequent worries voiced about bond yields as they dropped in the weak recovery of the past seven years—only to drop even further.
Yet, stocks are hot. S&P 500 earnings have been falling for 18 months, but Wall Street analysts are becoming optimistic again. Forecast operating profits 12 months ahead have been rising since February, and aren’t far from their 2014 peak. The now-maturing tech sector has done particularly well, with the so-called FANGs which led the market last year before plunging— Facebook, Amazon.com, Netflix and Google, now Alphabet—rebounding fast in the past month on the back of broadly better-than-expected earnings.
This reflects the basic market belief that the world economy is weak enough to keep central banks pumping out free money, but not so weak that company profits will dive. As Mr. Inker said, “That’s a very small sweet spot.”
Still, central banks provide a more reliable prop for shares than the madness under way in the markets in 1999. David Rosenberg, chief economist of Gluskin Sheff, who was deeply bearish during the dot-com boom, thinks there is no parallel in the bond markets today. “I don’t look at bonds as a bubble, I look at it as a controlled market,” he said.
Much depends on whether he’s right. If central banks both can and do keep yields low, U.S. equities look OK in comparison. One big difference between the excess of 1999 and today is for those who think that he’s wrong, and low yields are unsustainable. In 1999 it was easy to find alternatives to wildly overvalued tech, media and telecom stocks. It is harder to find anywhere to hide today, as the great central bank monetary experiment makes everything expensive.
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