There may be no better symbol of America at the present moment than the Nasdaq. Even a few years ago, most people might have mistaken "Nazzdak" (the way it's pronounced) for a former Soviet Republic in Central Asia. Only financial sophisticates knew it was the stock market for many growth companies--the country's Intels and Microsofts. But now the Nasdaq captures America's prevailing mood: the boundless optimism, the confidence in technological superiority, the romance of instant fortunes.
Gosh, it's exciting. America Online and Time Warner are merging. What an extravaganza! Though both AOL and Time Warner trade on the New York Stock Exchange, the Nasdaq is the true epicenter of this glorious upheaval. We have become a nation of tapewatchers, hungry for news of Yahoo!, Dell or Cisco Systems. In 1999 the Nasdaq composite index rose an astounding 86 percent. In the previous three years, the increases were 40 percent (1998), 22 percent (1997) and 23 percent (1996).
The Nasdaq has existed since 1971. Over the years, it has helped many bold new companies raise money to expand. But its latest surge must signify something larger. It must indicate that we've entered an economic wonderland, where old investment rules have been rewritten or repealed. This must be true, because if it isn't, the Nasdaq explosion would be a speculative bubble, which will ultimately burst or deflate. Heresy. Perish the thought.
One standard measure of stock values is the price-earnings ratio, or PE ratio. If a company has earnings (profits) of $1 a share and its stock sells for $10, then its PE ratio is 10. Between 1871 and 1996, the PE ratio for all U.S. stocks averaged about 14, according to Jeremy Siegel, professor of finance at the University of Pennsylvania's Wharton School and author of "Stocks for the Long Run."
What's the Nasdaq's PE? At year-end 1999, it was about 200, according to analyst Brian Rauscher of Morgan Stanley Dean Witter. Growth companies--with prospects for above-average increases in profits--might be expected to have above-average PEs. Sure. In the late 1980s, the Nasdaq's PE (the average for all the companies listed on the exchange) fluctuated between roughly 20 and 25. By 1991 it was about 40. In late 1998 it neared 100, and then doubled in the next year.
"There's never been a broad-based stock index [with] a PE anything like this," says Siegel. For comparison, he recalls the "nifty fifty" stocks of the early 1970s. These were the then-hot growth companies, including IBM, Xerox and McDonald's. At their peak in December 1972, the "nifty fifty" had a collective PE of 41. The priciest company, Polaroid, had a PE of 95.
Not to worry. We are, after all, rewriting history. Technology companies now can command unprecedented stock prices--often with meager profits or huge losses--because (as everyone knows) the Internet changes everything. Better yet, there's enormous room for growth, because (despite the hype) the business conducted on the Internet is still puny. In 1999 the Internet's retail e-commerce totaled $16 billion, estimates PC Data Online, a market research firm. Other estimates slightly exceed $20 billion. Whatever the true figure, it pales against total consumer spending of more than $6 trillion. It's even overshadowed by staid catalogue sales (an estimated $57 billion) and telephone marketing ($230 billion).
Never mind. Today's profits must be irrelevant, because tomorrow's opportunities are so vast. For the year ending in September, Yahoo! earned 21 cents a share. Its stock at year-end sold for $433. That's a PE of 2,062. Jeff Bezos, founder of Amazon.com, was Time's person of the year, although his company had cumulative losses of almost $600 million through September. (They are larger now.) By old logic, Amazon.com can't attract customers without price discounts and marketing expenses. By Internet logic, these huge losses represent "acquisition costs" that will ultimately reward Amazon.com with hordes of loyal, free-spending customers. At a recent stock price of about $70 a share, Amazon.com is valued at almost $24 billion. To earn a 10 percent return on that would require annual profits of $2.4 billion. This exceeds all of Amazon's 1999 sales.
But who cares? "Buy and hold" is for dummies. (That's the old investment rule of buying solid stocks at reasonable prices and getting rich as companies' profits and stock prices rise.) Why hold when you can sell at a quick profit? On a typical day, investors--individuals, mutual funds, pension funds--trade about 13 million shares of Amazon.com. This is one-tenth of the company's publicly traded shares. Put differently, there's a 100 percent turnover of the company's public shares every two weeks.
The Nasdaq now represents a growing share of America's paper wealth. At year-end 1999, its capitalization--the value of the shares of all its 4,844 companies--was $5.2 trillion. This was almost one-third of the worth of all stocks, $15.8 trillion. (Most other stocks are traded on the New York Stock Exchange.) At year-end 1996, Nasdaq's capitalization was a mere $1.5 trillion, less than one-fifth of the then-$7.9 trillion worth of all stocks. Surely, the Nasdaq's expanded wealth ought to reinforce our confidence in the market's rise and the economy's health.
John Maynard Keynes, the famous British economist, once likened the stock market to a casino. The more stocks came to be owned by people "who do not manage and have no special knowledge . . . of the business in question," the more speculative the market becomes. Traders grow increasingly unconcerned with "what an investment is really worth to a man who buys it 'for keeps,' but with what the market will value it at, under the influence of mass psychology."
Keynes died in 1946. Were he alive, he would inevitably be watching the Nasdaq. Doubtless, he would be so dazzled that he would reconsider and recant. Wouldn't he?