Outlook: A bullish year end
Friday 24 December 1999
Private investors who have been caught by the Internet bug, both as a sector to buy and as a means of dealing, have steadfastly ignored this. In their gleeful, headlong rush into equities they assume that the market will continue to defy gravity. We are in a world where paper fortunes are being made in a matter of hours. Internet stocks disappoint if they do not rise in value ten-fold on day one. Shell companies suddenly assume heroic valuations by the mere appearance of an Archie Norman or a Luke Johnson on the board. Most worryingly, some US brokers are now planning to import "margin lending" into the UK - enabling private investors to borrow money against the stocks which they then invest in.
Some of this, such as margin trading, is redolent of 1929. At the very least it smacks of the froth generated just before a bull market goes into decline.
So, can this sort of performance be sustained? First, the bull case. Based on conventional calculations, the market is now vastly overvalued since there is no prospect that earnings will be sufficient to support these ratings. But, hey, the new economy also has new economics. What matters now is top-line sales growth.
The Internet explosion will ensure this continues. Moreover, in the UK at least, Internet stocks remain a fledgling phenomenon - the US Internet sector is nine times bigger. Over here, telecoms dominates the technology sector. But this year the baton will be handed to computer services, software and Internet stocks.
Then there is the extraordinary wave of merger activity - pounds 146bn in Europe alone - which has helped underpin markets in 1999 and shows no signs of abating. The factors driving merger activity, cost-cutting and the need to maintain pricing power in a low-inflation environment, are unlikely to melt away.
Lastly, the economic cycle has been smoothed, if not abolished altogether. Interest rates and GDP growth now move in sync, not in opposite directions. This reduces the dangers of boom followed by bust, making earnings growth less volatile and stock markets less prone to violent corrections.
The bear case is that the US equity markets will finally succumb to a combination of concerns about inflation, bond yields and interest rates. When the US bubble bursts, the bang will be heard in London. Moreover, profits are ultimately what determines the value of a company. If the Internet has done one thing, it has introduced competition and the more competition there is the more earnings will be squeezed, or at least spread more thinly among more players. The Net also has the potential to destroy as many businesses as it creates.
The strength of capital markets also relies, in part, on the deregulation of labour markets and in this respect Europe still has a long way to go. Indeed, in some ways it is heading in the wrong direction. France is moving to a 35 hour week and Germany is retreating from the modest reforms proposed.
Finally, remember that 1999 has only been a bull market for those who invested in certain sectors. Utilities and retailers have underperformed by as big a margin as telecoms has outperformed.
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