What We Got Wrong: Part 2

This is the second part of a four-part series on investors' miscalculation of the impact of the Nasdaq's crash. Don't miss the first part.

Ahh, but corporate spending, that spending that we always pegged to interest rates, what's going on there? If you take rates down, don't companies start moving inventory? Don't other companies start construction projects and begin to spend again? Don't the corporations act "rationally," because the grease that moves the economy (interest rates) is now removing the friction that higher rates provided?

No.

I constantly try to get the temperature of the stock market on a month-to-month basis so I can make decisions about stocks. I know I thought we were more on a path to recovery when I saw a burst of orders in April. I thought it might be because of the rate reductions, but that's looking like a stupid judgment right now because May and June were so poor.

So what happened in April? Why did things get better? Put simply, the Nasdaq went up. That triggered corporations to feel better about themselves. In retrospect, this spur should have been obvious. I remember working out on the treadmill at the Four Seasons in Scottsdale (oh man, if you ever get a chance, go to that one) on the day of the surprise rate cut. A day later, Gary Bloom from Veritas Software(VRTS Quote - Cramer on VRTS - Stock Picks), one of the good guys, a real smart fellow late of Oracle(ORCL Quote - Cramer on ORCL - Stock Picks), was asked how business was. I will never forget his answer. He said that business had just gotten strong and that, as long as the stock market kept climbing, he suspected it would stay that way.

It didn't and it hasn't.

The linkage should have been much more obvious, except we had never seen anything like this Nasdaq rally before. We had nothing to compare it to. We had no ability to say, "You know, the last time the averages tripled overnight, we saw a big demand and then when they crashed we saw a decline in demand." And don't come to me with that 1929 stuff. The issues then were so very different and the stock market played a much, much smaller role in the economy than it does now.

Why did the Nazz play such a big role in the decline of corporate spending? Here are a few theories that make sense to me:

Stock prices became the self-worth of the people who ran the companies. They had to grow their stocks to grow their incomes. The best way to grow stocks is to acquire companies with stocks and then get numbers raised, so there was an incredible acquisition boom. The economy changed from one where you developed a business over a long period of time to one where you created a business for Yahoo! or Cisco or Nortel to buy it.

That business-formation-acquisition game drove the economy.

When your stock price was flying, you knew you had a tap on capital, so why not spend, spend, spend? The worst that could happen was that you had to do a spot secondary to pay for things.

Bankers were calling you every day asking you to finance, either into convertible bonds that converted into higher-flying equity or into stocks themselves. With financing so readily available to those who grew fast, you had to keep growing without thoughts of what could happen in a slowdown.

The market-cap factor. As the stocks went up, companies felt compelled to "grow into the market cap" by pumping up their companies' size. Little companies became bigger overnight, far faster than they ever would have before.

Initial public offerings were so easy to have that you literally set up a company just to take it public and that company would go and buy all of this equipment made by Nazz companies, particularly if it were Web-based. These companies all regarded the whole process as a branding exercise, replete with unbelievably large media budgets, incredible computer and telecom budgets and stocks that were fit to be issued and reissued.

This is the second part of a four-part series on investors' miscalculation of the impact of the Nasdaq's crash. Don't miss the first part, and be sure to watch for parts 3 and 4 later today!