The key is how to teach an Old Economy new tricks

'Will online dealing ever be more than a minority sport in the UK?'

It has not been a great few months for personal investors. Not only is the level of share trading falling but investors have been warned this is the riskiest time to investment for 30 years.

It has not been a great few months for personal investors. Not only is the level of share trading falling but investors have been warned this is the riskiest time to investment for 30 years.

The volume of trades on the London Stock Exchange and their value fell in the second quarter of the year. But the value was down only 25 per cent, and the volume was down 40 per cent. This shows the fall-off was more at the retail end than at the wholesale one. The greatest fall-off has been in internet share trading, with Charles Schwab, which has the largest share of the UK market, saying the number of share trades had fallen by more than half.

In a way, this is unsurprising. The combination of a new hot investment sector (high-tech stocks) and a new way to invest (online) was bound to generate more enthusiasm than could be sustained. So is this merely a pause, albeit a very marked one, in the growth of online share trading, or does it suggest that on-line dealing will never be more than a minor sport?

The answer to that will turn in part on whether it really is risky to invest now. A study by Harvard Economics shows the rise in share volatility in recent years has made investing inherently more dangerous. True, this conclusion is derived from US data rather than UK, but in terms of volatility the UK market is similar to the US, although the overall valuations are less demanding.

Providing personal investors are able to spread their funds over several investments and don't need their money quickly, they ought to be able to cope with volatility, if - and this is the big if - the fundamental conditions for investment are reasonable. Are they?

Sometimes markets have obvious messages built in. A few months ago, at the height of the New Economy boom it was pretty clear the upward swing was unsustainable and the only issue was when it might reverse itself. That was the obvious message.

The less obvious one was that the Old Economy stocks that had been downgraded in the switch to the new fashionable sectors might remain downgraded for a long time. At some stage, value investing must come back into fashion but that may be a long way off. As a result many people who got the first part of the story right got the second wrong. They got out of high-tech stocks, but have not done well with their subsequent value-investing strategy.

Looking ahead, it is best to stick with the New Economy/Old Economy distinction for a while yet, although the two will become ever more closely integrated. Many New Economy shares are likely to see several more months of trouble, though the New Economy itself will surge on. Investors are already appreciating that the greatest beneficiaries of the new technologies are conventional companies good at applying unconventional ideas. The problem is to identify the companies, for so many of them proclaim their e-competence without having much to back it.

For the pure New Economy companies the key will be the speed at which they can flip from loss to profit. In the coming months it will be harder and harder to raise money to fund loss-making enterprises.

There will be plenty of money, as there is now, for start-ups with a bright idea. But for companies three years down the line and still with mounting losses the picture is bleak. Somewhere out in the future is some big event, some big crash, that will signal the bear phase of the new tech market is over.

In the Old Economy, the immediate outlook is brighter. As the latest issue of the International Bank Credit Analyst points out, the UK market has been held back by two factors, both of which are reversing themselves, over-high sterling and rising interest rates.

The pound is now back to a sustainable level at around DM3.00; and the interest rate cycle is either at its peak or close to it. Without things to hold them back, shares should be able to perform somewhat better. Or put round the other way, provided the fundamental health of a company is sound, the market should be able to recognise and reward this.

This view is echoed by some London-based securities houses, including HSBC. One specific point made by them is that the equity-debt cost difference is now so large there will continue to be a flow of share buy-backs in the coming months as companies switch to financing by bond issues. This will help underpin share prices.

But the key, surely, will be to identify the companies able to use the new technologies to help their business, rather than see their margins cut away by them. The question to ask for all companies is the same: whether they possess or can generate competitive advantages that cannot be swept away as more and more activities become commoditised. Put simply: can the company command a premium for its output? If it can, fine. If it can't then it has to be number one or two in the sector to have a profitable future.

If the general investment climate is going to be more favourable, there will be solid rewards for such companies. Expect value investing to make a come-back; but only for companies that can charge for the value they themselves produce.