New economy meets old realities

Warren Buffett, chairman of holding company Berkshire Hathaway, just announced he’ll be staying out of the U.S. stock market until “businesses sell for less in the market than they’re worth.”

People used to listen to the Sage of Omaha once, before his credo that investors shouldn’t buy overvalued stock became just another old-economy superstition. After all, it’s different this time.

Having spent a couple of years as yesterday’s man, Buffett is pleasingly unrepentant, and more so for having seen the North American stock markets burn up massive amounts of paper value. Let us not mince words: the new economy has tanked. And it did so in precisely the way its critics said it would, by not delivering on the promises of growth that the values placed on stocks implied.

Another of yesterday’s men, John Kenneth Galbraith, laid out the schema in his A Short History of Financial Euphoria — published, mark you, in 1990, when only hard-core geeks had heard of the Internet. “Some artifact or development,” he wrote, “captures the financial mind,” and becomes the focus of speculation. Success in amassing wealth is taken as evidence of wisdom, and doubters are reviled, their objections “dismissed as the primitive refuge of those who do not have the insight to appreciate the incredible wonders of the present.” It’s different this time.

“There are those who are persuaded that some new price-enhancing circumstance is in control, and they expect the market to stay up and go up, perhaps indefinitely. It is adjusting to a new situation, a new world of greatly, even infinitely, increasing returns and resulting values.” It’s different this time. When this expectation is disappointed, both the believers and the fellow-travellers who hope to sell near the market-top panic and sell.

All this is familiar to anyone who watched the junior-mining market in the mid-1990s. That speculative episode collapsed quickly — but with an interesting twist, in that it helped to spawn a second bubble, in “e-commerce,” as junior exploration companies turned dot-com.

We watched the rush to the exits at the time, crossing a few companies off our stock tables every week. The electronic media and the mainstream press, and even some economists, analyzed the trend in a manner that was typically shallow. The mass migration was a sign that the old economy was dying and that mining companies were trading in their drills for domain names, and their picks for pixels. Technology was triumphant, and of course it was different this time.

They were wrong on several counts. The companies turning into dot-coms weren’t mining companies at all; they were exploration companies that lived off their capital. With no hope of raising any for mineral exploration projects, they’d simply found a sexier story. And that story was not technology, either: the dot-coms weren’t writing software or developing the next Palm Pilot; they were pitching crude retail business plans in e-commerce clothing. (Some companies went into Internet gaming or pornography, which were at least honest ways of making a living, by comparison with some e-commerce plans. Even stock promoters have to eat.)

It wasn’t the new economy at all: it was another pitch at the investing public in the hope that investors would see themselves as technology venture capitalists. And it worked for a while; stocks went from a nickel to a buck on the news that the company had struck a deal to buy a domain name and a concept for selling muffler tape, flea collars or instant oatmeal on-line. Anyone with cheap stock did quite well. Retail investors, as is usual, were properly skinned and dried, and their pelts fetched the usual price.

But this pitch did ignore a central reality in the world of e-commerce, which is that not much value is created in distribution. If it were, then back before there ever was a Web, wholesalers and retailers would have been stock market behemoths valued at hundreds times earnings. (It must have been different back then — but bad-different, not good-different.)

Now, even the real technology stocks have been hammered; most notably in this country, Nortel Networks, JDS Uniphase, and Research in Motion are all trading at less than a fifth of the prices they boasted in the late summer of 2000. These weren’t e-commerce hype acts: they were the bone and sinew of the new economy, companies with real products and real revenues. But the market — having given them a free ride on the supposed wave that would swamp the old economy — has come to the belated realization that growth is only part of value, that hypothetical growth is an even smaller part, and that a flexible interpretation of the idea of “revenue” is no part of it at all.

But has the lesson gone home? It doesn’t look like it. The Nasdaq, normally seen as a reliable barometer of the technology sector’s health, sits around 1,950 points; that level translates into prices about 160 times earnings or eight times silly — and that, after the 60% fall in the Nasdaq index in the past year.

The fact remains that investors are still looking for the big score, and a great many don’t see it in the old economy. Some sharper types have made good money in resource stocks over the past year — consider, for example, that anyone with money in the Toronto Stock Exchange oil-and-gas sub-group has made a 50% return in one year — but until the broader public shakes off its belief that speculation is better than investing, we may still see good money heading to the roulette table.