Something very odd is happening on Wall Street. As the Dow Jones powered towards the 11 000 landmark this week, applauded enthusiastically at the closing bell, Nasdaq, home of the glamorous technology and Internet stocks, has been moving in the opposite direction.
The two markets are increasingly being decoupled. On some 40% of trading days this year the Dow Jones – which measures the value of the traditional blue chip stocks – and the Nasdaq have moved in opposite directions. When the Nasdaq suffered the second steepest one-day fall in its history 12 days ago, dropping 6,2% in one season of trading, the Dow Jones actually rose. It all seems very confusing.
Investors have become used to markets marching in the same direction, not just within an economy but globally too. More times than one cares to imagine, the FTSE awaits the opening of the Dow before establishing its tone for the day.
So what is going on? First, the United States real economy – that of consumer confidence, growth and employment – continues to steam ahead, promising and producing higher corporate earnings at the point in the economic cycle when it was anticipated they would be in retreat as a result of the global crisis. Second, unfashionable cyclical shares like oil and chemicals have started to attract attention again.
But finally, and most importantly, some measure of reality is starting to descend on the e-commerce sector. Sure the US is as Net mad as ever: one newspaper, USA Today, even has a correspondent who has moved herself into the World Wide Webfor a year. Nevertheless, some of the faddishness may at last be recognised.
Back then to the US economy. Despite all the shocks of last year – from Russia to Long-Term Capital Management and a credit crunch – domestic demand climbed some 5%, up from 4,25% in 1997.
As the International Monetary Fund noted in its World Economic Outlook report, the US economy accounted for almost half the growth in the world economy and output last year. There has been a tendency to attribute this success to the new paradigm of the virtual economy. The reality is more prosaic.
The US is enjoying an extraordinary confluence of good economics: low inflation, low interest rates, low unemployment and rising budget surpluses.
It also has a remarkable capacity to recover from confidence setbacks. At the start of the conflict over Kosovo, confidence dipped but the latest indices show it restored.
Moreover, the buoyancy of the equity markets has added to the wellbeing, although it is as much increases in real incomes – up 4,4% in the first quarter of this year – as notional investment gains which has driven the US economy forward.
Among the consequences of this is that some of the old dowagers which make up the Dow Jones have been putting in better profits performances; some of the stars of the Nasdaq are still waiting to report their first profits. AT&T, which is turning out to be Wall Street’s biggest dealmaker, turned in a 42% rise in first-quarter earnings; Daimler- Chrysler managed to produce a 23% uplift; International Paper showed a 136,1% increase in profits and IBM – not so long ago regarded as the busted flush of the technology sector – managed a 9,9% gain.
The earnings power of the old guard has been demonstrated at a time when it has been lagging behind the Nasdaq stock. As a result there has been a steady flow of investor funds out of the Nasdaq into the Dow companies where price earnings ratios, although historically high, are not reaching into the stratosphere. In fact, they look remarkably modest in comparison.
Compare this with some of the stars of e- commerce. America Online (AOL)is at the forefront of the Internet revolution. In the first quarter of the year it delivered profits which tripled to $117-million, before taking account of the results from Netscape, the Web browser company it bought last year. AOL has been demonstrating that it is not the subscription fees which are critical to Internet service providers, but the income they are able to generate from advertising and commercial services.
Despite this, and an excited report from the company about the number of subscribers, now at 17-million, the shares fell back because growth failed to match market expectations for a company which is seen at the frontline of the wired revolution. Moreover, there is a sort of recognition that whereas AOL makes $117-million in a quarter, AT&T netted $1,7- billion in the same quarter.
At least AOL is growing at an exponential rate and producing profits. No such luck with that other denizen of the sector, Amazon.com. Instead of moving closer to profit, as its shares have soared ever higher over the last year, its deficit has been growing. Its losses increased to $61,7-million in the first quarter, even though it managed to almost quadruple the number of subscribers to 8,4-million.
As it moves into new areas, music and, most recently, online auctions, the potential for eventually moving into profit increases. But, as with AOL, the longer it takes to establish itself, the more chance its bookseller competitors have to catch up. Competitive advantage in Internet trading can quickly vanish.
There is no doubt that the Nasdaq’s victory over the Big Board for much of this decade reflects the reality of Microsoft and the potential of AOL and others. But there now appears to be a sensible rebalancing of investment portfolios in favour of some of the more established brands, some of which, like AT&T and IBM, have shown an ability to remake themselves.
Eventually economic reality in the shape of the widening US current account balance, higher oil prices, rising wage settlements and potential interest rate increases will catch up with both markets. Then it will be a question of how big the correction.
But the switch between the New York Stock Exchange and the Nasdaq could make the fall – when it inevitably comes – less dramatic.
ENDS
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