The Stock Market

Louis Proyect lnp3 at
Wed Oct 27 12:34:14 MDT 1999

Concluding paragraphs of "The rise and rise of the Dow" by Ibrahim Warde


The sacred rule that the price of a share is determined by the company's
profits is therefore being challenged, especially in the case of companies
involved with the Internet. How, indeed, can you evaluate the price to
earnings ratio of a firm whose turnover is insignificant and profits
non-existent? The answer is circular and tautological: the market is the
only judge of a share's value. On that basis, the flagship company of the
Internet economy, the virtual bookseller Amazon, is worth more than all the
major American bookseller chains together, but has yet to make a profit.
And the day after its floatation,, which sells cut-price
airline tickets, was worth $11.7 billion, more than any airline.

In short, the value no longer depends on underlying objective data but on
public infatuation. This makes accumulated losses almost attractive because
they can mean that the company is investing to carve out a lucrative niche
for itself, accelerate change or get a few laps ahead of its competitors.
In other words, to become the Amazon of tomorrow.

Gurus and charlatans are doing well out of this new gold rush. Extravagant
promises and superlatives feed the speculative fever. In this virtual
world, words often count for more than things. A company only has to add
the suffix ".com" or the prefix "e-" to its name for its stock market value
to soar (11). "Cybersquatting" (reserving an Internet address in the name
of a basic product or a well-known company or personality to sell on at a
high price) is all the rage. The designation "" was bought for
$824,000 by a company that wants to make it the address of a portal site
for pharmaceuticals. New Internet companies are also taking advantage of
massive stock market valuations to make major acquisitions. Yahoo! (whose
shares have gone up in value 250 times in one year) has just paid $5.7
billion for, a company with a turnover of no more than $22
million and with losses of $16 million -- "a paper transaction representing
virtual value for a virtual industry" (12).

Could this gigantic house of cards be blown away at any time? Periodically,
the chairman of the Federal Reserve continues to voice his fears. And in
its annual report on the US economy, the International Monetary Fund refers
to the risk of a "sudden and substantial collapse" in the stock market. The
similarity between the celebrity share America Online and that of Radio
Corporation of America (RCA), which rose from $1 to $573 between 1921 and
1929, is quite striking: both are the companies most typical of the new
technologies of their respective eras (13).

Are we heading for a repeat of the 1929 scenario? The most optimistic are
confident there are plenty of safeguards in place. Then, the markets were
almost unregulated, since the stock market policeman, the Securities and
Exchange Commission (SEC), did not see the light of day until 1934. It was,
for example, possible to buy shares by paying only a 10% deposit (the
minimum is now 50%). But with market deregulation, speculative funds like
Long-Term Capital Management have invested on the basis of a capital to
debt ratio of 1/100 (14). And false rumours, outlawed by 1930s legislation,
have assumed an unprecedented scale thanks to the Internet.

But the most worrying aspect remains the growing part of the real economy
held by the financial economy. While stock market capitalisation accounted
for only 50% of America's gross domestic product in 1988, it is now over
150%. The stock market portfolio now represents 25% of the average
American's assets, as against only 8% in 1984 (15). In 1997, 43% of adult
Americans invested on the stock market, compared with 21% in 1990. Their
stock market investment trusts totalled $13 billion in 1990. The present
sum is $231 billion (16).

The media are full of stories of good fortune. The street sweeper who asked
to be paid in the shares of a "start-up" and became a millionaire the day
the company was floated. The humble secretary who retired in luxury thanks
to a system of stock options. Captivated, some Americans are giving up
their jobs to become "day traders" - devoting all their time to
speculating, monitoring the performance of their stocks and shares minute
by minute. Taxi drivers and hairdressers share their theories and
recommendations with their customers. And the singer Barbara Streisand
unveils the secrets of her successful stock market portfolio to the
financial journals.

It was thinking about a similar infatuation that enabled Joseph Kennedy
(father of the assassinated president) to avoid financial ruin. One morning
in 1929 his shoe-shine boy gave him an investment tip. The seasoned
speculator reasoned that if the shoe-shine boy knew better than he did,
there was something rotten in the world of finance. The same day, he sold
his entire stock market portfolio.

Louis Proyect

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