Last Week's Rally, This Week's Caveat

The ease with which the Dow Jones Industrial Average and the S&P 500 moved to two-week highs, rising each day last week, brings to mind the effortless performance of some of our greatest athletes -- Magic Johnson in basketball, Tiger Woods in golf, Willie Mays in baseball, Walter Payton in football.

Before Friday's employment number, stock pundits were once again paralyzed with fear, intoning that no one wanted to take a position before the announcement. But the day once again witnessed a heroic rally, with the Dow jumping 202 points and the S&P climbing 27.

As we've said before, it's so easy -- from the halcyon vista of the armchair or the solid support of the cane -- to buy when the eye of the hurricane hits. Buy on the beaches, buy in the streets, buy in the air and -- if by some improbability the Nasdaq does go down someday -- buy then especially, because there's sure to be a rally. The Nasdaq rose only three out of five days last week, ending up 7% on the week and 20.7% on the year.

The 72-point bounceback in S&P 500 futures last week was the third-largest rebound of all time, placing it in the pantheon with the weeks ended July 2, 1999, and Oct. 16, 1998. Such events are unfortunately relatively bearish; the indices manage to sustain their levels one week later only one-third of the time, a low enough degree of uncertainty to border on the typically used standards of statistical significance.

With Friday's celebration now over, we offer this further caveat to the rampant bullishness. Economist Ludwig von Mises points out that we live in a society of consumer sovereignty, where the customer is the captain who drives the ship and pitiless consumers determine exactly what it is that producers should produce to satisfy their needs. The result is that consumers get the quality and quantity they want when they want it, without intervention.

The same is true in the market, and supply does expand to meet demand. That's why there are no shortages in the supermarkets or the stock markets, and that's also why collectivism crumbled all over the world, except in a few lonely outposts such as American academia and Cuba.

But when supply does catch up to meet demand, prices have a way of coming down. Over the weekend, Vic received proposals and business plans for no less than seven Internet-based companies, including one from each of his two older daughters, two from his merger partner in Atlanta, one from a professor in criminology and two unsolicited over the Web. Such an abundance of supply waiting in the wings cannot be bullish for the Internet stocks when the pipeline gets filled in a year or two.

Bear in mind that since Vic's fall in Thailand in October 1997, he has been one of the least likely potential investors in venture-capital companies. Like most who have been through a famine, he husbands his resources carefully. If Vic is receiving half a dozen proposals a weekend, imagine what the real heavy hitters are receiving -- and imagine what that means for the prospects for Internet stocks down the road.

Unlike Peter Lynch, who benefited from his wife's visits to the shopping mall, we aren't privy to oracles from our significant others. But sometimes a homely indicator, like the number of submissions of Internet ventures over the weekend, can be quite significant and possibly predictive.

In truth, the last time that Vic was offered so many venture-capital start-ups came at the height of the 1996 run-up in Russia, when the indices showed gains of 600% to 1,000%, and the rate of return for those who specialized in the leveraged purchase of debt was into triple figures. Our mysterious source -- let's call him Mr. X -- has a theory as to what exploded the Russian bubble. It was what he calls a "moral gratuity" gone awry that got the Russians so ticked off that they refused to demean themselves any further by paying any interest until they were given increased borrowing limits.

As to what will cause the comparable pricking of the Internet bubble, we don't know. But we predict it will start on a Tuesday, as did the death of Tulip-mania in 1637 -- when out of the clear blue sky, a bad auction of bulbs led to pandemonium and disaster.

While biotechs have been every bit as exuberant as the Internets, it's much harder to start a biotech company because you have to know your RNAs and DNAs. The supply of such knowledge seems much lower than the supply of ideas for dot-coms, a realization, no doubt, that figured in the reasoning of Merrill Lynch's Henry Blodget, who last week reiterated his opinion that most Web companies are doomed to fail.

So rather than buying any Internet venture that comes across our horizon, we think it's time to get down to basics. In this modern, funky economy, memes and potential are the basics, not P/Es. In view of the timeliness of our research, we are burning the midnight oil and will be reporting our pathbreaking discoveries during the current week. Stay tuned for more memes, reader Frank Linet's patent picks and the XYZ index.