Thursday, March 10, 2005

Memories of halcyon days

The Wall Street Journal

Many of the dot-com darlings of the late 1990s are gone, but memories of those days persist.

Investors have grown more leery of profitless wonders. Watching the tech-stuffed Nasdaq Composite Index skid sharply from its record of 5,048.62, reached five years ago today, has a bracing effect. The index would need to post a 144 percent gain to get back to its previous record levels.

Still, even with the Nasdaq composite record so distant, the eagerness for quick riches is hard to squelch. Indeed, after an investing bubble, an echo bubble - in which investors rush in to buy all over again - isn't uncommon.

In market experiments conducted by George Mason University professor Vernon Smith, who shared in the 2002 Nobel Prize for economics, participants trade a dividend-paying "stock" with a clear fundamental value. A bubble invariably forms and then bursts. If the experiment is repeated with the same people, a bubble forms again. The second time, though, participants think they will be able to sell their positions before trouble strikes. Participants express surprise that they weren't able to get out before the second collapse.

In the wake of the Nasdaq collapse, this echo-bubble phenomenon doesn't seem to have occurred in quite the same way as in the lab. Unlike Smith's experiments, in which there is only one thing to trade in, the world offers investors myriad choices.

The zaniness that characterized 1999 and the early months of 2000, when shares of untested companies built on blue-sky expectations could skip 30 percent higher on the slightest scrap of news, for the most part doesn't exist any longer, says Doug Kass of the hedge fund Seabreeze Partners. He says much of the mania has shifted into real estate.

Along with price jumps in many housing markets, 23 percent of U.S. home sales last year stemmed from investment purchases, according to the National Association of Realtors. Kass says people he knew from near his Palm Beach, Fla., home who were day trading stocks in 2000 now are real estate brokers.

"We have day trading in homes instead of day trading in stocks," he says. "It will end the same way, and it will be the same guys delivering the product."

Yale University economist Robert Shiller, who like Kass had a negative view of the U.S. stock market in 2000, also says the real estate market is where the speculation is. Although his survey work shows that investors still have a positive view of stocks, he says that view reflects more grudging optimism than glee.

"I think there was a mood change," he says. "It's not fun anymore. It was fun in the 1990s, and everyone was talking about it."

Recent surveys by Shiller show that homeowners are most optimistic about real estate as an investment if they live in hot markets, such as Los Angeles. Recent buyers tend to have the rosiest view about real estate as an investment.

The two things - the euphoria that pushed the Nasdaq past 5,000 and the excitement for real estate today - aren't unrelated, says William Sterling of Trilogy Advisors, a New York investment-advisory firm.

During the bubble years, there were huge wealth gains in places such as the San Francisco Bay area, where many of the dot-com companies were based, and the New York metropolitan area, where much of the banking was getting done. Much of that wealth went into real estate.

After the stock market slipped and the United States went into a recession, the Federal Reserve cut short-term interest rates to soften the downturn. After the Sept. 11, 2001, attacks, it cut rates even more. This had the effect of buoying housing prices, particularly in those markets where they were buoyant already, Sterling says.

Real estate isn't the only place where some think the Fed's rate cutting set off speculation. James Grant, editor of the newsletter Grant's Interest Rate Observer, says the Fed's moves helped drive greater speculation in the credit markets. The difference, or spread, between the yields on speculative grade corporate debt and Treasurys has been nearly halved in the past five years, according to Standard & Poor's. A narrowing of that spread means investor appetite for risk has increased.

Not only did the Fed lower its key short-term interest rate, taking it to 1 percent in '03 from 6.5 percent at the end of '00, it was slow to begin raising rates again, Grant says. It recently has raised rates in a methodical fashion that has made bond-market participants confident about the future course of rates. Such confidence can encourage speculation.

"The Fed, trying to repair the damage from the stock market bubble has succeeded in fomenting what to me is the greatest of all credit bubbles," Grant says.

At the same time, many say stocks, though not in a bubble, aren't cheap. Comparing stock prices with their earnings in the past 10 years, stocks look rich, says Cliff Asness, principal at Greenwich, Conn., hedge fund AQR Capital. Historically, high stock valuations by this measure have forecast paltry returns in the next 10 years.

Some posit that the speculation of the Nasdaq era has become spread over a number of asset classes, leaving none of them in a bubble but making them all seem generally unattractive. A common complaint among investors these days is that they can't find anything really inexpensive worth buying.

At the same time, expecting the speculative spirit, particularly among stock market investors and especially if those investors are Americans, to go away may be an idea as far-fetched as the expectations that coursed through the Nasdaq in March 2000.

"The desire to get rich quick never dies," says Morgan Stanley strategist Byron Wien.


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