Summer Rally, Autumn Panic?
July 6th, 1999

Some individuals make more difference to the character of a nation than others, but none are irreplaceable. It is a precarious organization, indeed, that is tied to the character or personality of a single person however great he or she may be. No organization could survive under such conditions for very long.
Ervin Laszlo

In the quiet old days before the dawn of the Information age, someone once said that if you ask five economists what they think about the economy you'd get five different opinions; six, if one of them is from Harvard. That joke was supposed to illustrate the complexity of economic forecasting (and make fun of Harvard). Most web surfers today wouldn't even get the joke.

Online there are thousands--no, make that millions--of conflicting opinions about what the markets are going to do tomorrow. The noise to signal ratio today is exponentially higher than anything investors have had to deal with in the past. The unhappy truth is that everyone is just going to have to think for him or herself. Now that's a scary thought!

I only mention the multifarious clashing voices on the Internet because last week a strange and rare calm in the cacophony of pro-offered scenarios developed.

Perhaps it was the odd aligning of the markets; the Dow, NASDAQ and S&P 500 all closed at record new high tides on Friday. That, combined with the Fed's surprise notice that they'll hold no bias either way towards interest rates going into their next meeting in August, seemed to unite the pundits, the analysts, and the brokers into an unusual synchronicity of opinion. Yet another scary thought!

Suddenly the labyrinth of voices on Wall Street began to chant in unison: "summer rally, autumn correction". Each analyst has his or her own shaman's bag of reasons for this prophecy, but they all contain the same essential elements illuminated by slightly different angles of light.

First, everyone is expecting a strong batch of earnings announcements in July. Most analysts feel the S&P 500 will see earnings gains anywhere from 12% upward to 15% since the US economy posted a 4% rate of growth in the second quarter. Earnings are increasing largely because productivity just keeps going up.

Those of us who work with technology every day realize that productivity gains, due to advancements and breakthroughs in hardware and software, will continue indefinitely. The corporate implementation process lags well behind the cutting edge of most technologies, enough to guarantee decades of year after year productivity gains. Most of Wall Street is still skeptical of claims like the above and are shocked every time productivity and growth expand while inflation stays firmly leashed.

Old schoolers were surprised that the markets rallied last Friday on the news that the Purchasing Managers Index and the employment report both came in somewhat stronger than expected. Increases in both are sure signs of inflation in an industrial based economy, but haven't yet proven to be reliable indicators during the Information Age.

Then there are the technical gurus who point out that the markets rising or "confirming" in unison the way they did last week suggest more lofty highs in the next few weeks. Other obtuse indicators babble a confusion of signs, such as the Specialist Short Ratio, which signaled the start of a rally, while the Overbought/Oversold Oscillator is at levels unlikely to be a strong base. Worst of all, the Advance/Decline ratio does not support this rally by a long shot, nor are bonds behaving in a healthy fashion. Technicians, however, will always shrug off uncooperative indicators and milk the trend while it lasts.

Of course, the tulip market of the Internet IPOs again led the way last week, confirming that the current bubble mentality of this market is still firmly in control. As Edward Chancellor points out in his new book, Devil Take the Hindmost, "The modern investor is just as liable to be whipped up into a frenzy over companies introducing a new technology as the diving engine "cullies" (dupes) of the Projecting Age."*

Wednesday of last week, Ask Jeeves (ASKJ), an Internet IPO debutante rose 365% on the first day. Ask Jeeves' gimmick is a "state of the art" question answering search engine. Unlike many technology IPOs, Ask Jeeves sports a concept even your grandmother can grasp, perhaps explaining it's mass appeal to less than savvy speculators. As historian James Grant points out, "Progress is cumulative in science and engineering but cyclical in finance."

The universal predictions of a hot summer rally was, well, predictable. But the almost universal agreement that the market must rapidly correct or even crash á la Black Monday of October 1987, I found rather foreboding. After all, it's clear that the "intrinsic value" of the stock market (an oxymoron if ever there was one) was exceeded years ago and this hasn't been an issue. The US economy is firing on all cylinders. The world economy is coming back strong from the Asian flu. That's bad news for US bonds, but who cares? A worldwide economic recovery is the ultimate goal. So, what's the problem?

Most observers feel that the market will correct sometime in the August to October area. My own informal survey suggest that most are thinking in terms of a 10% to 15% correction from whatever top our little summer rally is going to claim. (Perhaps 11800?) Some advise moving back into a strong cash position by the last week of July.

The most morbid analysts aren't invited to freely express their opinions on CNBC. The worst of their fear stems from the possibility of a Y2K induced market panic. No one involved with the technology thinks that the physical affects of Y2K on the digital infrastructure of the globe are going to be more than an annoyance. However, the human folly factor and its vast potential for panic based on hype and legends is an unknown variable in any equation for the near future of the stock market.

According to the conventional wisdom now in vogue, the convergence of high bond yields, record market volume and price levels, combined with the deeply ingrained fears of Y2K mythologies make for a very hazardous autumn. Bubbles do not deflate, they burst.

There is also some evidence that the mutual funds, with their massive gravity, will be moving to a strong cash position to ride out the entry into the year 2000. This alone could be enough to set off a market panic in association with the highly charged air of le fin de siécle.

Once the hype of possible panic passes, the sky becomes the limit as IT managers begin to shift resources away from the Y2K problem and back towards innovating productivity gains for the next year. Indeed, no matter what happens, the year 2000 AD should be a very good year for markets all over the world.

What does all of this mean for Apple? Well, I think that Steve Case's (CEO of AOL and a guy worth millions on the flimsiest of premises) recent investment of millions in the asset heavy Maui Land and Pineapple Company says it all. Get your money out of the over valued securities that don't have any real value and buy into real estate and under valued asset-rich companies like Apple that sport PE ratios well below market averages. The stocks with value beyond today's latest fad or fear should make a comeback in any correction and will fair much better than their high flying brethren in the advent of panic.

Meanwhile, the deck party on this, the world's largest, longest running, and patently unsinkable bull market goes on and on. Pass the champagne! Just remember there aren't enough lifeboats for us all.

*The diving engine "cullies" were the witless speculators who lost their whole investment in diving engine corporations set up in the 1690's to employ new state of the art patented technologies to recover gold from ship wrecks. The diving engine companies became all the rage in England, even though most of them never actually looked for, much less recovered, a single coin from the sea. The price of shares in these well-hyped corporations soared as long as there was a one size bigger fool to sell to. By 1697 the bubble burst; all the diving companies disappeared and the "Devil took the hindmost".

Laszlo, Ervin. The Systems View of the World, A Holistic Vision for Our Time, Hampton Press, 1996.

Chancellor, Edward. Devil Take the Hindmost, A History of Financial Speculation, Farrar, Straus, Giroux, 1999.