Before I pass out the blue books from last week's
pop quiz, class, let me just say that I found many of your responses to be intriguing. The range of your perspectives was quite wide. You'll recall that I asked you to consider what might happen to Old Economy stocks as the
targets the "wealth effect" if New Economy stocks prove immune to monetary restraint. For extra credit, you were asked to examine prospective relative performance if in fact the New Economy proves susceptible to Fed action.
I gave top marks to those who noted that current total U.S. stock market capitalization is estimated at $14.2 trillion. Chairman Greenspan and his colleagues prefer that this magnitude should grow no faster than the rate of income growth -- let's use recent data and call that 6%. (For the purposes of today's discussion, we'll assume away the issue of wealth in the form of fixed income and real estate holdings.) The Fed's target market cap would then be $15 trillion a year from now. If you noted in your blue book that the current market cap of the
is $5.8 trillion, or 40% of the total, you were able to develop several scenarios of possible future outcomes. For example, if the New Economy Nasdaq is unaffected by Fed action -- let's assume it continues to compound at the same 42% average annual rate that has been its record over the past five years -- then all non-Nasdaq names as a group will have to decline by nearly 20% from current levels in order to achieve the Fed's target market cap. More of one will mean less of the other.
Since we met last week, there has been a real-world exercise in response to our blue book quiz. When Chairman Greenspan made his way to Capitol Hill on Wednesday to reiterate his
testimony to the
Senate Banking Committee
, he had the immediate effect of knocking down Old Economy indexes while simultaneously stimulating the animal spirits of New Economy stocks. The Nasdaq rose almost 1.0%, while the
fell by 4.0% on the week. What should we think of market divergences such as this? The Greenspan Fed apparently would call it a good start.
Nevertheless, with the Nasdaq within a whisker of its all-time high, it's impossible to make the case that the Fed has had any effect whatsoever against what it perceives to be the excesses of the New Economy. The Nasdaq has certainly been undeterred, so far, by Fed threats; it continues to rise right in Greenspan's face. Likewise Senators
, who sharply questioned the necessity to target "wealth" and committed a rare act of
against the Fed chairman by suggesting that perhaps he is not so all-knowing.
Greenspan was too polite to suggest to the senators that as monetary theorists they are fine ballplayers. (Bunning's perfect game for the
and Mack's namesake grandfather are immortalized in Cooperstown.) But Greenspan struggled, apparently unsuccessfully, to explain to them the difference between intermediate and target variables, between means and ends. Mack is the sponsor of a so far unsuccessful effort to rewrite the legislation that directs the Fed in its objectives. He would have the Fed guide solely by a "price stability" rule, a
standard, ignoring other feedback information that the Fed now employs to inform its actions. Such a rule would compel the Fed to stand pat today, and would have required the same inaction during the Russia-
crisis in 1998. For the school of thought Senator Mack represents, the more complex the world becomes, the more simple the rules should be.
For those of you who argued that New Economy stocks are immune to Fed action, let me ask you what stocks you like in here. Name your favorites. Do you own them? Do you own a lot? Now consider this: Why don't you own more? Is it because you lack conviction? Or is it perhaps that you lack the liquid cash or the borrowing power to be as big as you would like to be in your favorite positions?
If you think that your favorite New Economy stocks are bulletproof, are immune to the grim reaper of Independence Avenue, you may have ahead of you an expensive lesson from the school of hard knocks. Tuition there can make Ivy League bursars' bills seem like a plea for spare change.
Let's lapse once again into monetary theory, specifically that of
, coiner of the pithy assertion that "inflation is always and everywhere a monetary phenomenon." The Friedman school holds that money is, in effect, a scalar, that it can determine the absolute level of prices but has only weak effects on relative prices, or the relation of one price to another. This is the proposition that underlies our pop quiz. Today's market environment may be about to test it.
closed the week valued by the market at a total capitalization of $87 billion.
went out with a total cap of $48 billion. The relative price of Yahoo! in terms of GM is 1.8 times; the market values this particular new economy stock at nearly twice that of the old nuts and bolts business. That's neither right nor wrong, just closing market prices.
If investors don't have bigger positions in their favorite stocks because they lack the money or the credit to be bigger, and if Greenspan and Co. continue to drain the pool of money and credit, then investors in aggregate will either have to sell their Old Economy holdings in order to maintain positions in New Economy stocks, or sell them all proportionately, the Yahoo!s and GMs alike.
In the short run, the market may sacrifice the old to preserve the new, but as time and the economic effects of monetary austerity wear on, the gaping divergence between old and new is likely to close with a bang. When new money and credit becomes scarce in the system and when old assets have been sold to the walls, the liquidity that is the ultimate bulwark of New Economy stock valuations will dry up. When that time comes, New Economy stocks may still be worth -- in our particular example -- 1.8 times Old. But in terms of cash, they may be worth half of what they go for now.
Jim Griffin is the chief strategist at Hartford, Conn.-based Aeltus Investment Management, which manages institutional investment accounts and acts as adviser to the Aetna Mutual Funds. His commentary on the financial markets is based upon information thought to be reliable and is not meant as investment advice. While Griffin cannot provide investment advice or recommendations, he invites you to comment on his column at