Wall Street is still scratching its head over the big drop in the
Nasdaq's highfliers. Why was it that tech and biotech shares went from so loved to so disdained so quickly? How did so many companies' stocks get halved, or worse, despite no essential change in outlook?
But for a growing number of market watchers, the more relevant thing to ask is why these stocks went up in the first place. From its October lows to its March highs, the
Nasdaq Composite Index
gained 87.7%. The
Morgan Stanley High-Tech 35
tacked on 95.2%, trough to peak. And the
American Stock Exchange Biotechnology Index
shot up 216%. It was an unprecedented run, and swell as the new technologies are, it's still hard to make sense of it.
"There were a lot of wonderful things going on," says Bill Sterling, chief investment officer of
, a New York-based money manager. "But we already knew the Internet was there. We knew the Human Genome Project was nearing completion."
Sterling now believes that the rally in technology shares -- not just in the U.S., but all over -- had little to do with any change in the company's fundamental prospects and everything to do with central banks aggressively pumping money into the world's banking system.
Each of These Things...
Source: Federal Reserve
Heading into the new year, the
Federal Reserve and its counterparts around the world worried that individuals and investors, jittery over potential Y2K disruptions, all would rush to the bank window at once to withdraw funds -- a panic that, as Sterling describes it, would be something like what happened to George Bailey in
It's a Wonderful Life
writ large. To prevent this, central bankers pumped huge amounts of money into the world's banking system.
In hindsight, now that we know that about the biggest Y2K problem most people had was remembering to write the year 2000 on their checks, the banks having pumped money into the system seems a bit ridiculous. Meanwhile, the monetary base -- currency and currency reserves -- in the U.S., Japan, Europe and Britain spiked sharply higher, and that money needed someplace to go.
"The Fed basically increased the monetary base by $41 billion as a precaution against Y2K," says
market strategist Doug Cliggott. "And actors in the financial marketplace turned a fair amount of that liquidity into rocket fuel for the Nasdaq."
...Looks a Lot...
Why the Nasdaq, and not Old Economy stocks? Or Florida real estate? Or
Beanie Babies? For one, because the financial risk-takers were into the Nasdaq highfliers even before the Fed opened wide the spigots. Had the speculators been in real estate -- as they were when the monetary base expanded in Japan in the late '80s -- that would have been what shot higher.
"Central banks, in order to soothe the nerves of the most conservative investors, ended up emboldening the most speculative," Sterling says.
One of the transmission mechanisms for this was margin debt -- borrowing from brokers to buy stocks -- which grew at an unprecedented rate through March. Basically, by pumping money into the system, the Fed left banks with a lot of money on their hands to put to work. "Where was the easiest place to lend?" asks Sterling. "Guess what? All of the brokerage firms had their hands out, saying, 'We want to increase margin lending.' Did money cause the spike in the Nasdaq? Almost certainly."
...Like The Others
Source: New York Stock Exchange.
Since January, however, the growth in the monetary base has contracted, and with the
Federal Open Market Committee raising rates, it probably will shrink some more. The Nasdaq's rocket fuel supply has been cut back sharply, which may mean more troubled times for the index.
"If, in fact, it was that liquidity that brought it up," says Cliggott, "I don't think it would be outlandish if a tightening of liquidity brings it down."