Pop Goes the Internet

Was that the sound of the Net-stock bubble bursting?
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Pop.

Did you hear it? There was a distinct "pop" in Internet stock-land a week ago today. Who would not call such a dramatic, gut-wrenching, fear-inducing fall at least a correction, if not worse? Because surely, if a bubble were to burst, it would look something like Internet stocks did last Monday.

One need look no further than

TheStreet.com Internet Sector

index, a measure of 20 prominent Net stocks. That index, traded on the

Philadelphia Stock Exchange

, hit a record high of 824.2 on April 13, but then began a breathless fall, plummeting 32.6% in just four trading days. It was nothing short of a massive, hyperfast bear-market move. On Monday alone, the market capitalization of

CMGI

(CMGI)

,

CNet

(CNET) - Get Report

and

Yahoo!

(YHOO)

fell more than $8.48 billion.

While individual stocks have skidded dramatically from time to time, the breadth of the recent spill shook confidence in the highflying group.

The crash of Net stocks made a few headlines. But more telling, the reverberation thumped through the Internet economy and spilled over into the rest of the U.S. stock market.

"Thirty-two percent, is, by any definition, a correction," says Michael Fitzsimmons of the London-based hedge fund

Lodestone Capital

. "And, if you were long any of these names, it sure felt like a correction." Indeed, the classic definition of correction is a 10% drop, a bear market a 20% drop. When the

Dow Jones Industrial Average

crashed on Oct. 19, 1987, it fell 22.6%. So was this it? The crash we've all been waiting for?

Well, before the nattering nabobs of Net negativism had a chance to celebrate a crash, the online issues came roaring back. In three days, the TSC Internet Sector index had pared its loss to 20%. CNet, in particular, just missed hitting a new all-time high. So what happened? Was it a hypercrash and a hyperrecovery, as some economists are now calling the rapid comeback in Asia? Or was the Internet redefining volatility, just as it has redefined everything else?

"You have to understand that professionals who own these stocks don't sleep easy," says Fitzsimmons. "They're looking for the first excuse to get out." That excuse, some say, came from, of all places, yes,

The New Yorker

. An interview with

Morgan Stanley Dean Witter

analyst Mary Meeker had her offering the hackneyed comparison to Europe's tulip craze in the 1630s and saying, "We will have a big correction in Internet stocks sometime this year." (The article also strangely identified her as an "investment banker," an error akin to calling a pitcher a catcher.) It may not have been much, but one negative comment from one of the most respected brokerage houses on the Street was enough for some folks.

But here's the rub. The selloff actually fueled a strong recovery. Here's how: 82.8% of fund managers underperformed the

S&P 500

last year, and they missed the chance to participate in the Net stock run-up. "These people owned good companies that happened to be crappy stocks," says Scott Bleier, chief investment strategist with

Prime Charter

. "But all of a sudden, the deep cyclicals -- manufacturing, oil companies -- they've lifted off of long-term bases. And these guys sold."

Bleier and other market watchers suspect that fund managers who had been avoiding the Net found a rare opportunity to jump on the bandwagon. "And it wasn't just

AOL

(AOL)

for a change," says Bleier. "On that drop, institutional investors were buying

DoubleClick

(DCLK)

, CNet, CMGI, a little

Lycos

(LCOS)

, a little

eBay

(EBAY) - Get Report

."

"You saw a cyclical whipsaw," says fund manager Garrett Van Wagoner of

Van Wagoner Funds

. His

(VWEGX)

Emerging Growth and

(VWPVX)

Post Venture funds rank Nos. 1 and 3 among all diversified small-cap mutual funds, with 79.7% and 78.5% returns this year, respectively. What he describes is a classic sucker's rally, akin to Bleier's observation. "You had all these guys dumping Net stocks, trying to grab onto a run-up in cyclicals, only to see the Net stocks take off again. So they dumped the cyclicals and tried to get back into the Net."

But was it a crash? Perhaps not -- even at its worst, the TSC Internet index was still up 38% for the year. But two things are clear from last week's action. First: "The definition of 'correction' has to change," says Fitzsimmons. "Because a 32% fall still has these things trading at ridiculous valuations."

And finally: The Net bubble's bursting may just have brought more investors to the Net. Curiouser and curiouser.