by David Roskoph, MBA, CFP

Will the King's recent draft become a cold?

    Since this "New Era" began I have been asking you not to dispense with all those old, tried-and-true, rules that have established financial markets for the past century. New Eras have been heralded before with their attendant market exuberance as that change was assimilated into the economy. The economy was not reinvented or fundamentally altered with these innovations but rather, it assimilated them. So too will the economy adapt to the internet. The internet will change the way business is done and over the next few months the ambiguity of that change will gradually disappear. What seems clear is that some things will remain forever changed, such as product and information distribution. Unclear however, is the degree to which the new technologies will alter existing consumer patterns. Equity prices are often credited with the omniscience to represent the future until it becomes the present. The market has bought into a lot of future profit through technology. Popular stock indexes like the Standard & Poor's 500 have been greatly affected by the most recent New Economy. Due to the violent shift toward technology within the S&P500, it is likely to disappoint investors as the euphoria of tangible corporate profits.

    A distinction must be drawn between the internet as a source of retail commerce and the internet as a source of information. As a source of commerce, the internet was built too quickly to ensure profits. There was little time for a protracted and calculated evolution because the rush to be first-to-market obscured the bottom line of profitability. In a historical instant, consumers were freed from centuries of middlemen and costly intermediaries; catapulted past decades of thumbing through catalogues or shuttling between malls. Freed from the encumbrance of such friction buyers plunged, wallet first, into a sea of cheap buying opportunities. We all love a bargain and after all, the internet built itself as the ultimate price leader. Consumer confidence remains lofty as American consumers consume themselves into a collective deficit. The problem for internet commerce is unlimited competition for virtually the same goods = no pricing power. In addition, the most of entering the competitive fray is minimal; thus the perpetual price war is ensured longevity. With no time to evolve a sound profit strategy, internet distribution of products, was doomed from its inception. As explored in the last article (The New Economy Math Just Doesn't Add Up, Aug 2000 ), dot.com retail profit margins alone cannot support the cost of maintaining present customers let alone acquiring new ones in light of the apparent lack of conventional loyalty. As Amazon is proving - if the biggest and the best can't make it, what is supposed to happen to the rest?

    As the new versus the old cataclysm rages, even the venerable S&P500 Index is brought into the fray. Over the last decade the S&P500 has gained great fame as an investment vehicle because it has outperformed most mutual funds with the same objective and risk parameters. The S&P500 is capitalization weighted and considered passive because companies are rotated in or out dependent upon their capitalization, i.e. the performance of their stock. Alternatively, an actively managed fund is directed by the manager's theory of the future performance of a collection of stocks, not tied to market capitalization. Tremendous amounts of money have flowed into S&P500 Index funds because of their stellar and steady performance, 28.69% (before costs) average annual return from 1995-1999. The S&P500 has ten components or sectors such as utilities, financials, and technology. Not long ago, technology represented only 3% of the S&P500 Index; today technology represents approximately 33%! This happened because over the last two years, investors could not put enough money into the New Economy companies like Yahoo, Palm and Qualcom. As money poured in their stock, their capitalization rose and they were invited into the S&P500 family. Each of these companies is trading at stratospheric earnings multiples well into the hundreds, based upon very questionable growth projections. The inflows of capital into these companies and the resultant 1000% increase in the technology component of the S&P500 has clearly gotten out of control. Already each has lost between 65-75% of its highest market value. As the profit potential of the New Era settles in, the S&P500 is likely to be overweighted in technology to the detriment of overall performance. Investors may be disappointed with the returns of the S&P500 versus many actively managed funds over the next five years because the popular rush to technology stocks has corrupted the indexing process itself.

    Presently, the public considers the internet the rebirth of capitalism. In fact, the prospects of selling information over the internet for a profit are real, however, we are not yet that dependent upon information alone. Each time major innovation occurs, everyone forgets the experiences of the past while they are mesmerized by the seemingly endless possibilities that the new technology portends. It seems that each generation must experience this phenomena for themselves and turn a deaf ear to history. Unfortunately the dead can't communicate with the deaf.