New Economy stocks: Have they hit bottom?

Prolonged decline brings tech equities more in balance with Old Economy stocks.

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Financial reality has returned to Wall Street.

Shocked by the tragedies in the Middle East, beaten down by higher interest rates, soaring oil prices, a batch of weaker-than-expected corporate earnings, and a slowing economy, stock prices have retreated dramatically this month. Investor confidence has been shaken.

To some analysts - and perhaps the Federal Reserve - this bad news has a bright side. It has taken some of what Fed Chairman Alan Greenspan a few years ago called "irrational exuberance" out of the stock market.

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"Stock prices today are much closer in line with fundamentals," says Alan Skrainka, chief market strategist at Edward D. Jones, a St. Louis-based retail brokerage.

A huge plunge in prices Thursday dampened the celebration of the 10th anniversary of a glorious bull market. The Dow Jones Industrial Average of 30 Blue Chip stocks fell 379.21 points, or 3.6 percent, to 10,034.58 - close to the cherished 10,000 marker.

On Friday, however, enough bargain hunters jumped into the market to boost averages, especially the technology-laden Nasdaq Composite Index. Also, some market technicians - those who follow price trends - forecast a bottom in the market.

"It was due for a bounce," says David Blitzer, chief economist in New York of Standard & Poor's, an investment research firm.

So far, most economists see the economic expansion continuing at a healthy, though slower, pace. Relatively few worry about a recession.

The broad market picture is one of greater balance. Stock prices better reflect the basic worth of New Economy and Old Economy companies.

"We are getting to a more rational level," says Michael Flament, an economist with Wright Investors' Service, a Milford, Conn., firm managing $4 billion.

The numbers tell the story: After rising a startling 86 percent last year, the Nasdaq index was down 39 percent at the end of trading Thursday from its high last March.

That high, says Gordon Richards, chief economist of the National Association of Manufacturers in Washington, was "completely unrealistic."

Internet stocks, even more volatile, were down 60 percent from their March high, according to an index maintained by Goldman Sachs, a major New York investment bank.

Some individual Internet stocks were down even more: Priceline.com, 95 percent, DoubleClick, 90 percent.

"All of those people who rushed into stocks believing that the P/E didn't matter have been disabused of this belief," notes Cynthia Latta, an economist at Standard & Poor's DRI, a Lexington, Mass., consulting firm. "Earnings do matter."

The P/E is the ratio of the price of a company's stock to its earnings. It's a common way to estimate a stock's appropriate value.

Stocks in hot tech firms often had P/E multiples of 40, 50, 100, even more. Some had no profits, only rapid growth.

With the dive in many tech stocks, new respect for the Old Economy has returned.

Stocks of traditional companies - making and selling goods, working the forests and mines, providing basic services, such as in banking and finance - tend to have far more modest P/E ratios, reflecting their weak popularity until recently.

The Value Line Composite index of 1,700 stocks, mostly Old Economy, has an average P/E ratio of 14. That's about half the P/E multiple for the S&P 500 Index, a sign of the fact that 30 percent of the total value of all 500 stocks is in technology firms.

Edward D. Jones's Mr. Skrainka expresses pride that his firm last March recommended its clients keep only 20 percent of their portfolio in tech stocks, at a time when some brokers were suggesting 75 percent. "It was a silly idea to put all your money in the New Economy and dump the Old Economy," he says. "Broad diversification is best."

Nonetheless, revenue growth remains rapid in parts of the New Economy. In August, new orders for computers were up 34 percent and for telecommunications equipment up 19 percent from a year earlier. Stocks of computermakers, battered earlier last week, bounced back on Friday.

False dichotomy

In a way, according to Don Carlson, the terms Old Economy and New Economy are "a distinction without a difference." Mr. Carlson is president of the Association for Manufacturing Technology, a trade group of 290 mostly machine-tool makers.

These members, though usually thought of as Old Economy, make the high-tech machine tools that are used by both Old Economy and New Economy firms. A recent study the group commissioned found that their technologies have contributed greatly to the recent surge in productivity, adding in effect $1 trillion to the United States economy in the past five years.

"I find it puzzling that good quality companies will miss their earnings expectations by two or three cents and their stock will drop 20 percent," he says.

Robert Parks, a Wall Street economist, explains that happens because some investors justify high P/E ratios by projecting high earnings and profit growth far into the future. If that growth slows slightly, it means their projections come way down - and so does the stock price.

Still overvalued?

In a report last March 10, Mr. Parks warned that the high-tech "bubble" would burst. That day the Nasdaq index peaked.

"Pure luck," admits Parks. Forecasting a sharp slowdown in the economy, he thinks stocks are still overvalued.

Ms. Latta of DRI, which reckoned stocks were 25 percent overvalued last spring, now says they are fairly priced or slightly underpriced. But that doesn't say stocks couldn't fall further.

"Typically price swings go too far on the upside and then too far on the downside," she says.

(c) Copyright 2000. The Christian Science Publishing Society

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