'Deflation of this particular bubble is probably a good thing'

Brian Tora

Volatility is a word seldom far from the lips of investment professionals these days. Debates take place on the subject and there are ratios to tell you the risk you are taking as a consequence of specific investment volatility. The bad news is that volatility is here to stay.

Volatility is a word seldom far from the lips of investment professionals these days. Debates take place on the subject and there are ratios to tell you the risk you are taking as a consequence of specific investment volatility. The bad news is that volatility is here to stay.

If you bought a technology unit trust at the beginning of March, you will probably find it hard to reconcile experience with the fact that deflation of this particular bubble is probably a good thing. The valuations accorded to these stocks were racing away. Looking at NASDAQ performance - which many people take as a warrant on US technology stocks - compared with that of the Dow Jones Index, you find that divergence only really started towards the end of 1998 and did not achieve lift off until the second half of last year.

The first thing to ask is why? There seems little doubt that technology was deserving of a re-rating. The business model will change dramatically because of exponential growth of the worldwide web and our ability to use it for all manner of transactions. As important, probably more so, is the use of new technology in the way in which businesses interact.

America knows this and is developing the new approach to business at breakneck speed. That is the main reason for the continued robust growth of the American economy and its ability to deliver superior returns whilst not fuelling the fires of inflation. But like so many cycles, prices travel too far in the direction in which they are driven. In the case of US technology stocks it has been the domestic investor that has contributed to the scary ratings.

In the UK the private investor has played a part, but not to the same extent. One reason why our own FTSE 100 Index has been so volatile is that it is now heavily influenced by so called TMT stocks. By the beginning of March, technology, media and telecoms accounted for 30 shares in the Index, but nearly half its value. By the beginning of this week share prices had fallen to the extent that these three industrial groupings were worth only a little over a third of market capitalisation.

The shake out may not be over. One technical analyst, writing in a report this week, described the technology sector as having formed a perfect double top. In other words it had further to fall. And if it does go down further, it will probably over react on the downside as well. It would also be wrong to believe this has never happened before. Looking through a market report written nearly thirty years ago, I was struck by the reference to a "two-tier market of remarkable proportions". Does this sound familiar? New economy versus old economy last year perhaps? It seems that to be a successful investor you need to have a good understanding of history. The next few weeks may prove difficult, but the cult of the equity seems sure to live on.

Brian Tora is Chairman of the Greig Middleton Investment Strategy Committee

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