The Descent into Darkness April 17th, 2000 Margin accounts, like little stars in the night sky, are going out all across the heavens. In the illiquid blackness of our darkness market nightmare there are only fevered asks without a bid in sight. Like everyone else who took up positions in the market recently, the Mac Observer virtual portfolio of technology stocks is under water. Like everyone else, we're grasping for straws to explain what's happening in the market and how long it will take for things to return to normal. Of course, "the norm" for the stock market in the last year has been a total aberration by any historical measure. The Nasdaq was up over 80% year over year-- that's about 500% better than the historic average. Meanwhile, volatility has been ratcheting steadily higher to levels never experienced in the Nasdaq's 29 years of operation. The Dow has reached levels of volatility not seen since October 1987. Even after the Nasdaq gave up 35% of its gains from the all time high of 5048 on March 10th, the market remains up about 40% from a year ago, still a record 52-week gain for the Nasdaq. This so-called correction is just now gaining steam and could blossom into a full scale global panic this week. Markets that live by momentum die by momentum. The Wall Street Journal disingenuously attributes the high market volatility to online traders with instantaneous access to news. Wrong! The Internet has changed the dynamics of the stock market by creating the largest and most egalitarian equity market in history. But the market volatility is the result of the super-high valuations of many technology stocks rather than Wall Street's newfound trend towards equality through networking technologies. When a stock like Yahoo or Cisco rises above any imaginable valuation that can be justified by fundamental analysis, all an investor can do is turn bearish or find a new rationale (such as touting a "New Economic" Paradigm) to account for the high price of this stock. Bearishness has its disadvantages. People flamed my column when I predicted that a severe crash was coming, as I did on March 13th. Most bears have been in hibernation after learning painful lessons about shorting markets with growing parabolic curves. They're coming out of their caves this spring and they're hungry. The only way to win in a soaring market with no underlying fundamental support is to play the momentum game. After all, once the market is cut loose from any rational moorings, how can you assign a meaningful valuation to a stock? Technical Analysis, Momentum and Greater Fools Buy the stocks that are going up! Duh. With triple digit PE ratios there is only one reason to buy into companies like Yahoo and Qualcomm: their prices are rising. But you can't buy and hold at these ridiculous levels. Buy and hold is what you do with value, not hype. And that's why the market is volatile. The corollary of the momentum trader's axiom-- "Buy hot stocks that are soaring"-- is that there must be a greater fool waiting at the top to buy the worthless paper. As soon as momentum swoons, you've got to bail out. Until recently, the supply of greater fools seemed infinite; now, the opposite effect of downside momentum is occurring: with zero fools to sell to, the devil is taking the hindmost. This week is either going to 1) be a miraculous comeback, or 2) get really, really dark and scary as sanity returns to an insane market in the form of panic. The Miraculous Come-Back Scenario Institutional and retail investors could see the low on Monday, April 17th, of (just guessing) 2950 on the Nasdaq as the buying opportunity of the decade. After all, the premise of the New Economy is that stock prices have been historically too low for the level of risk they entail. Furthermore, this correction is not the beginning of a bear market by any traditional standards. Last week's market crash was a complete disconnect from the hot US economy, which is happily chugging along at near-record growth and productivity rates. Inflation is hardly an issue. What's unfolding in the equity markets is a technical market correction. Unlike past bull market tops, this one does not herald an upcoming business cycle downturn and so it can't last long. The highly oversold Nasdaq has retraced a comfortable Fibonnacci ratio to the downside and is ready for a bounce. The good news emanating from the strongest technology earnings season in a long while could cut loose a torrent of buyers. Because of the accelerating effects of the Internet, the market recovery could be reduced to weeks instead of the months required in the past for market drops this steep to rebound. The Nuclear Winter Scenario Get real! The best technology stocks are still highly overvalued. Yahoo has a price-to-earnings ratio of 591, while Qualcomm's is 275. The average P/E ratio of the Nasdaq 100 is currently about 150--historically it has been in the 30s. There hasn't been real fear and capitulation among the investors of these bloated behemoths. The Titanic hit the iceberg, but they're still dancing in first class. Yahoo, currently a $116 stock, could sell off to $70 per share and still sport a regal P/E of 300! The psychological effect of such a sell off would crash even the low P/E stocks, like Apple's, back to levels not seen since last year. A true market panic could ensue, liquidity could dry up and the markets spin into an out of control free fall, at least temporarily, through support at 2500. Good earnings reports couldn't save the market last week, so why will they save it this week? Especially with IBM likely to actually miss earnings with flat revenues, and Microsoft lamely propping up their weak growth with one-time gains by selling some of their investments. Lucent is also scheduled to report this week and no one expects any upside surprise from the company. Moreover, a stampede of frightened investors taking advantage of any uptrend to get the heck out of the way will quash any bounce back rally, while technical traders will use every uptick to short. The real kicker is the short week: markets are closed on Good Friday, further perturbing the safety of routine. There will be more people in church this Easter. The real bottom to this crash could be much lower. There is no sound fundamental reason for it to stop here, while there is a strong technical argument for a loss-of-confidence free-fall to 2000-2800. It may take another week or two to get there. Then an extended period of sideways trading in the range of 2800 to 3500 is likely while the survivors lick their wounds and bury the dead. The good news is that the world economy is strong. A stock market crash from these heights is unlikely to change the business outlook, except for companies leveraging their market cap inappropriately. After every dark night comes a bright morning. Most of us will still be here, I trust. Your comments are welcomed.