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Just Another Manic Market

While investors debate a tech bubble, we're getting signs that a bubble mentality is coming back.

Editor's Note: This column marks the debut of The Signal and The Noise, an attempt to direct investors to meaningful information in tech stocks amid all forms of noise -- whether it be public relations ploys, shaky accounting, bad management or silly conventional wisdom.

There was a quiet but telling moment earlier this month when two of the investment banks that had led the underwriting of's

(BIDU) - Get Baidu Inc. Report

explosive IPO initiated coverage on the Chinese search company with underperform ratings.

That's right. This is a stock that has lost half its value since going public not even two months ago. Even at such a hefty discount, Goldman Sachs and Piper Jaffray were warning investors to stay clear.

Neither worried about Baidu's future. It was a question of valuation: Both felt the stock price -- currently around $77 -- would


to approach reality around $45. Goldman analyst Anthony Noto pegged Baidu's implied value at or below the $27 offering price.

And that sums up the market for technology stocks in 2005, or rather the market's split personality. You have some people -- to their credit, Goldman's and Piper's analysts among them -- who are trying to adhere to the hard lessons of the recent crash in the


, which is still 59% down from its March 2000 peak.

Then there's the camp of investors who, if they remember the tech crash, do little more than pay lip service to its lessons. A few short years after lifetime fortunes were wiped away by speculative trading, it's mind-boggling to think that someone wouldn't think twice before paying $153.98 after Baidu's IPO.

Tech mania is on its way back. Sure, the speculation is contained in a few isolated pockets, and there remain bargains in the tech sector for investors willing to do their homework. And tech companies keep surprising with new innovations, which may give careful investors genuine opportunities.

But it also gives careless investors false hope that the spectacular returns promised in the 1990s may finally be here.

Much of the press is still in the 2003 mentality that investors are once-bitten, twice-shy about tech stocks, as they were in stories commemorating the five-year peak of the Nasdaq last March. The

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San Jose Mercury News

, for example, declared, "investors remain deeply skeptical of tech stocks" and quoted a strategist that it would take another 10 years for tech stocks to reach the old highs.

Others, like former stock analyst Henry Blodget, offered anodyne rationalizations to numb painful memories of the crash: "Our exuberance helps build industries, however boneheaded it may later seem," he wrote in an op-ed in

The New York Times

last month.

Blodget is right that the tech industry is doing just fine. But for investors, complacent thinking about stock corrections is just as dangerous as complacency during bubbles. It's just when everyone is so certain that there can't be another bubble that it becomes possible again. And the idea that a bubble like we saw in the late '90s is a once-in-a-generation occurrence is especially misleading.

"It's true that bubbles are separated by a long period of time on average," says Stefan Nagel, a professor of finance at Stanford's Graduate School of Business. "But they're not going to be separated by the same amount of time every time. So, that's not a safe assumption."

In fact, there's reason to believe that the demand for shares is already growing faster than the supply. As housing prices stabilize, or even correct in the overheated markets like Florida and California, some of the speculative money that drove it higher will be desperate to find a place that can offer more returns. Besides the stock market, where can it go?

Some of that money may already be heading in. According to TrimTabs Investment Research, more than $2 billion has flowed into U.S. equity funds alone in each of the past two weeks -- more than double the $900 million average this year.

Nagel says there are clear signs, both quantifiable and behavioral, that mark the beginning of a return to a bubblelike mentality. One is an increase in stock volume and another is a rise in buying stock on margin. While volume on the


and Nasdaq is steady and at most rising slightly, margin debt in August stood at $208 billion, even higher than it was in November 1999.

Among the behavioral signs, Nagel points to investors trading more for near-term gains rather than for buy-and-hold strategies -- an ethic alive and well in stocks like Baidu.

Another is a willingness among daytraders to make a living at stock trading. While that's hard to measure, Ameritrade's average daily trades did increase 29% in August from a year ago.

None of this is meant to argue that a broad-scale tech bubble is back, only that the mania mentality that precedes a bubble is stealthily returning to the market, just when few are expecting it. To have a full-fledged bubble, you need obscene valuations; and the average P/E on information technology stocks in the

S&P 500

is around 20, less than half its 2000 peak.

On the other hand, that price-to-earnings ratio never dropped far below 20, while a ratio of 10 or lower is more typical of a bottoming-out figure. And that raises the possibility that the last bubble never fully deflated and that maybe we're just in the tranquil eye of a very long bear-market hurricane.

Alan Newman, who edits the bearish stock newsletter


, says investors feeling bullish about stocks are blind to a bear market that began in 2000 and that has another decade to unfold. "In tech stocks, valuations are anything but fair," he says. "


(MSFT) - Get Microsoft Corporation Report

trades at 6.96 times sales and


(INTC) - Get Intel Corporation Report

trades at 4.06 times sales. No one in his right mind would make a private purchase of either company at their current valuations, so why would anyone buy a share in them at their current valuations?"

Whether it's a prelude to a new bubble or the second act of the old one, the persistent belief that we're safe from the mania of speculative investing -- belied by factors like surging margin debt -- can't be a good sign.

"You can't have a bubble when everyone knows there is a bubble," says Stanford's Nagel. "There has to be some people who don't believe it. It's the greater fool theory: You can speculate as long as there's a greater fool to sell to."

This could make 2005 like the sequel to a zombie movie: The Return of the Greater Fool.

At the time of publication, Kelleher had no positions in stocks mentioned