Byron's Index Shows Investors Still Buying Everything

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Will the dreaded market collapse of 1998 be remembered as little more than a blink-and-you-missed-it mini-bear market?

Apparently so, if the emerging consensus on Wall Street is any guide. I, for one, don't buy any of it, and as we'll see in a minute, my reasons in large part have to do with the renewed speculation of day traders and momentum fund operators in Internet stocks. But never mind that. For the moment, gloomy sentiments are out of fashion on Wall Street, where it is often said that a wise man never fights the tape.

These days, investors prefer to focus instead on the apparent bottoming out of the

Dow Jones Industrial Average

, which has by now regained more than half the ground lost in the slide that began back in July. Historically, the Dow's tops have been at about 20 times earnings, while its average has been approximately 16. With the Dow now hovering at around 23 times earnings, is it possible that this is a bottom? To hear the technical commentators tell it, it is. It has been comforting, for instance, to hear such commentators as the widely followed

Ralph Acampora

of

Prudential

reverse their earlier forecasts of an approaching downturn and say -- to quote from Mr. Acampora's Oct. 28 commentary to clients -- "We feel the cyclical bear market is over."

Whew! I guess those folks really know what they're talking about, too, or else why would they be turning up on

CNBC

to share their wisdom with me and the rest of the investing world's shut-ins? It's really quite humbling, I must confess, to listen to the likes of Mr. Acampora declare, with the conviction that must come from exhaustive research, that the recently concluded bear market actually "did us a favor" by "creating more sober investors ... and tempering

Wall Street's 'buy everything' mentality."

I was sure glad to hear that the buy-everything mentality had been tempered, because it was getting out of hand. Remember back in June, when

Amazon.com

(AMZN) - Get Report

doubled in price in three weeks? Frankly, it was giving our pet index, the

Internet Sucker's Index

, fibrillations. For a stock like Amazon to double in price every three weeks, why, you'd be looking at $393 trillion inside of a year!

But given all that, I'm sure you can share in my consternation upon discovering -- in spite of Mr. Acampora's soothing reassurance to the contrary -- that a stake has apparently not yet been driven through the blackened heart of Wall Street's buy-everything mentality after all. We offer the following sentiment we've been encountering everywhere lately -- that the recent drop in the market wasn't a signal to get out, but rather a chance to pile in more aggressively than ever. So, folks, it's time for a periodic visit to our widely followed Internet Sucker's Index -- the only investment barometer on Wall Street specifically designed to correlate stock prices to outright stupidity. This week's message from our statistical oracle: Investors are getting dumber than ever.

The Internet Sucker's Index is, like Paris in the '20s, best understood as a moveable feast -- not least because, unlike other indexes such as the Dow and the

Standard & Poor's 500

, it is constantly growing. When we first set up the index back in April of this year, we scoured Wall Street for every public stock offering of the previous two years that had presented itself to the public as an "Internet" stock, and came up with a total of 18.

But, just as the 17th-century Dutch speculation in tulip bulbs began with one bulb only to spawn an entire horticultural industry devoted to the creation of new varieties, so too has the Internet IPO business spawned an entire buckets-and-broomsticks brigade of Wall Street road warriors devoted to replicating and elaborating upon the success of the first Internet IPO of them all:

Netscape

(NSCP)

.

Result? There are now 38 such stocks in the index -- one or two (like

America Online

(AOL)

and

Intuit

(INTU) - Get Report

) because they're aggressively moving to redefine themselves as Internet-based operations, others (like

Peapod

(PPOD)

) because we missed them the first time around, and still others (like

GeoCities

(GCTY)

and

Broadcast.com

(BCST)

) because they didn't even exist when we first set up the index.

The best measure of the index's growth is not the aggregate rise in its price level -- you can see the resulting excesses on that score easily enough by simply looking at the individual stocks in the index. For a real insight into what the index tells us, we need to look instead to the aggregate market value of the index itself.

From that perspective, we can easily enough see what is really going on here. Just as the Dutch tulip craze soaked up so much of the nation's wealth that, when the bubble finally burst in 1636, the destruction of capital was so severe it plunged Holland into a depression, so too is the Internet binge staking claim, week after week, to a growing share of the stock market's aggregate worth. Consider the fact that as of early July, when both the Dow industrials and the Internet Sucker's Index touched their peaks, the index carried a market value of roughly $61 billion, or nearly as much as the sum total of the American aerospace and defense industry.

We won't belabor the point that America, as a nation, is likely to gain greater strategic security in the world by investing its resources in

Boeing

(BA) - Get Report

or

Raytheon

(RTNA)

than by pouring its treasure into

Yahoo!

(YHOO)

at 78 times trailing revenues. Suffice it to say that since July, the Internet Sucker's Index has grown to a market value of $74.4 billion, as of Oct. 29, and is now equal, amazingly enough, to fully 3.5% of the entire market value of the Dow industrials.

Now, in case you don't realize it, the Dow industrials include such behemoths as

IBM

(IBM) - Get Report

,

AT&T

(T) - Get Report

,

General Electric

(GE) - Get Report

,

General Motors

(GM) - Get Report

,

McDonald's

(MCD) - Get Report

and

Exxon

(XON) - Get Report

, among 24 others, collectively employing more than 3.5 million people pumping more than $67 billion in profits into the economy annually. The Internet Sucker's Index, on the other hand, includes the likes of

Go2Net

(GNET)

(75 employees) and numerous other equally forgettable operations, giving jobs to a mere 25,000 people, and producing, with the exception of America Online and

eBay

(EBAY) - Get Report

, no profits at all. So, keeping in mind Mr. Acampora's comforting observation that the buy-everything excesses have finally been wrung out of the market, one might safely say: Tell that to the folks who've been setting themselves up in recent days for a world-class screwing in the shares of the aforementioned Internet horror stock, eBay.

In case you missed it, eBay is an Internet auction house that went public at 18 per share on Sept. 24 and within 25 trading days was selling for 84 per share. Much of that gain came in just two trading days -- Oct. 26 and 27 -- when the shares nearly doubled in price to an intraday high of 91 on the hardly unbiased prediction of an analyst for

Donaldson Lufkin & Jenrette

, which co-underwrote the IPO, that eBay would go to 100 per share "within the next six months to a year."

Thanks to the prediction, eBay's shares were most of the way there within 48 hours -- accomplishing in two days the same sort of doubling stunt that had taken Amazon three weeks to pull off back in June. Were this doubling act to continue (which no one expects), by Thanksgiving, eBay would be worth $813 trillion, which is more money than eBay could hope to raise if it were to conduct an Internet auction for every dollar-denominated asset on earth.

As all serious investors know, eBay isn't worth even a fraction of its current market capitalization of $3.3 billion. More than 90% of the company's 39.8 million shares aren't registered for public sale, are not being traded, cannot presently be borrowed against, and can't be sold into the market even after they are registered without devastating the current price. The reason the price shot from 18 to 91 is because the float is so thin (3.5 million shares) that it takes no increase in demand at all to create dramatically rising price levels.

And that, in turn, points to the basic gimmick that firms like

Goldman Sachs

(the lead underwriter in the deal) have been working for well over two years now in these junk-equity IPOs: Bring these highly speculative issues to market at way, way under their likely demand in the second market, then hope that the expectation of a wildly surging demand created by day-trading speculators will induce institutional buyers to take a piece of the action. Thereafter, of course, the prices stay aloft only until the particular sector (or subsector, or "story" behind the stock, or whatever hype got it going in the first place) falls out of fashion -- at which point the stocks crash instantly back to earth.

Remember

K-Tel

(KTEL)

, the music retailing outfit? The company had traded for years on

Nasdaq

at less than 4 per share. Then, on April 9, someone at K-Tel put out a press release saying the company was planning to open a retailing site on the Web, and within a month K-Tel was selling for nearly 40. Eventually the company actually did open a Web site, but by then the speculators and day traders had lost interest in the stock and it was too late. Today, the stock is selling for (split-adjusted) 13 per share.

The K-Tel story is instructive, because music retailing is now the song that Jeff Bezos, chief executive of Amazon, is singing for investors in that overpriced stock. When the Sucker's Index collapsed in mid-July, Amazon stood at a peak of over 140 per share -- driven heavenward on wildly overblown hopes of the company's prospects as a "virtual retailer" of books.

But Amazon had never made a penny on its books business, and the more books it sold, the more its losses mounted. Worse, sales growth itself had begun to slip as competitors like

Barnes & Noble

(BKS) - Get Report

opened their own online sites. So, last spring, we all started reading of Mr. Bezos' big, new plans to have Amazon broaden from books into the retailing of music CDs.

On Oct. 28, the world finally got to see where this Big New Idea was leading: Nowhere, as Amazon released third-quarter financial results. They showed that while revenue grew fourfold to $153.7 million, net losses grew fivefold to $45.1 million, as the company keeps investing every dime of revenue in hopes of capturing that first dollar of profit. In the process, Amazon has turned itself into a welfare dependent on the capital market.

There is no point in raking over the frightful finances of a company like Amazon, which, in the wake of its third-quarter numbers, nonetheless soared close to 7 per share because the numbers weren't as bad as they could have been. Nor need we dwell on the fact that while eBay is now profitable, and may even at the outside reach earnings of 60 cents per share by the year 2001, its current price of 84 makes utterly no sense no matter how well you think it will do in the future. That price level does, after all, translate into a three-year-forward price-earnings multiple of 135, which is three times as rich as the multiple that Wall Street is now giving

Microsoft

(MSFT) - Get Report

-- by far the most consistently strong earnings-generator of the last decade.

There's no point in dwelling on those matters because they are not what is driving the stocks in this sector in the first place. With due respect to Mr. Acampora, no one cares whether these companies make money or not. All they care is whether their share prices keep rising. It's the same sentiment that drove the biotech boom of the 1980s, the new issues craze of the 1960s, the Florida land bubble of the 1920s, the tulip frenzy of 17th-century Holland.

In sum, what's driving this boom is greed, pure and simple, as captured and expressed in the minute-to-minute speculative trading of day traders looking to grab a fortune on the cheap and get out before it's too late. Enough said.

Christopher Byron tracks the financial markets for several outlets, including The New York Observer

. He appreciates your feedback at

cbyron1@home.com.

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