Last week's shocking announcement by WorldCom, or WorldCon as it is becoming known, brings to a dismal conclusion one of the worst half years the market has seen in decades, providing what could prove to be the world's largest-ever fraud to join Enron's dubious title as the world's largest-ever bankruptcy. Confidence is clearly shaken, but is it, as some are saying, the end of the cult of equity?
I think not. People still need somewhere to put their savings that will enable them to maintain their real spending power when they reach retirement. And contrary to the lurid headlines, there are still many companies making real things and selling them for real profits. These companies pay real dividends out of real cash. The most likely outcome from the WorldCom revelations is that investors will finally turn their back on most of the new economy and seek sanctuary in the old.
They have been doing this for some time, of course. The market capitalisation of WorldCom ahead of its announcement was $2bn, 99 per cent down from its level in April 2000. Over in Europe we have seen similar falls from grace for Vodafone and France Telecom, not to mention Marconi. The boom has been followed by bust.
What is important, how- ever, is that both boom and bust were contained within a relatively small area of the economy, the telecoms, media and technology sector. Lost among all the noise this week was the news that the US economy grew at an annualised rate of more than 6 per cent in the first quarter of this year.
Fear has certainly replaced greed as the main driver of sentiment, but we should be careful in ascribing all the rise in TMT stocks to greed. For many it was fear on the way up as well; fear of not being in a rising market drove the decision to invest in the new economy. This was particularly true in the UK, where the dominant institutional investors measure their performance against market bench- marks. As we famously saw earlier this year, it doesn't matter if your client's portfolio rises in value by 20 per cent; if the market goes up 30 per cent you are deemed to have failed.
The rapid rise of the TMT sector was thus at least in part a function of the benchmarking system. With pension fund managers required to more or less track the performance of an agreed market, usually the FTSE All-Share index, the arrival of TMT stocks into the benchmark almost forced them to buy – regardless of any concerns they might have had about earnings. At the height of the bubble the situation was further distorted by other technicalities such as the "free float". In simple terms, if a company sold 25 per cent of its shares on to the open market for £1bn, it was given a market value of £4bn. Institutions then had the near hopeless task of trying to match the official weighting in their portfolios.
The system made otherwise rational people behave irrationally. Remove this constraint and rational behaviour reasserts itself. As the TMT companies shrink in terms of market capitalisation, investors no longer need to own them. Meanwhile, the specialised mutual funds that sold the tech dream to individual shareholders are seeing redemptions as these investors also seek to limit their capital losses.
I suspect the fall-out from the recent stock-market scares will be a greater focus on real assets, real cash flows and real dividends. We bought the dream, partly because we were forced to, and we are living the nightmare. The new economy doesn't need any more investment capital right now and we aren't going to give it any. We'll stick with what we know. A case, perhaps, of no techs please, we're British.
Mark Tinker is global head of debt and equity strategy at Commerzbank Securities.
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