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The Global Market Strategist®

November 30, 1998

In his 1841 book, Extraordinary Popular Delusions and the Madness of Crowds, Charles MacKay describes several investment schemes gone awry, including Tulipmania, the Dutch flower frenzy that redefined European garden styles while making and breaking huge fortunes (for more info, go to the Website of Barnes and Noble). Historians now refer to Tulipmania as a "misguided enthusiasm" of the past since after the great fortunes were made on rising tulip prices in Holland, the subsequent collapse of the market threatened Holland's very economy.

In fact, "post bubble-burst" economy is perhaps the single best way to describe the Japanese economy of the 1990s. In the decade prior, speculators drove Japanese stock and real estate prices through the roof and on toward valuation levels not seen hence. Once again, the ensuing collapse in the wake of this modern version of popular delusion and the madness of crowds threatens the second-largest world economy and renders its government virtually helpless to restore the structure of its financial system.

There are many other historic instances of manias, including the infamous near-vertical stock market advance of the late 1920s of which author Frederick Lewis Allen writes in his 1931 account, "Only Yesterday," the kind of investor psychology that prevailed after every correction:

"But had the bull market collapsed? On June 13 it appeared to have regained its balance...A few thousand traders had been shaken out, a few big fortunes had been lost, a great many pretty paper profits had vanished, but the Big Bull Market was still young....

"...The lesson was plain: the public simply would not be shaken out of the market by anything short of major disaster."

Today, we find the U.S. stock market soaring yet again after this year's sharp decline that lopped 40% to 60% off the top of the average NYSE and NASDAQ stock. At the cutting edge of investor speculation during this month's advance are internet stocks, which have soared to levels that, seemingly, no other stock has gone before. But is that really true? Again we find precedent for such feverish speculation in "Only Yesterday:"

"All the old markers by which the price of a promising common stock could be measured had long since been passed; if a stock once valued at 100 went to 300, what on earth was to prevent it from sailing on to 400? And why not ride with it for fifty or a hundred points, with Easy Street at the end of the journey?"

Today's why-not-ride-it-for-fifty-or-a-hundred-point stocks are big name Internet stocks such as Netscape,, Ebay, and Yahoo. These stocks have simply gone crazy, with Ebay, for example, coming out as an Initial Public Offering only three months ago at 25 1/4 but hitting a new high this month at an eye-popping 234 1/8.

Similar stories can be found in other internet stocks., Inc. carries a 52-week low of 24 11/16 and a record high established this past week at a whopping 233 1/8. Yahoo--an Internet search engine--has performed similar acrobatic feats.

The most frightening part of all of this, along with its historic 1929 parallels that occurred in Frederick Allen's eyes only yesterday, is that these stocks have either never produced a profit or have only managed to eke out a small profit for one quarter. has lost money every quarter since it emerged, and in fact its losses have accelerated to $0.90 per share in the quarter ending September 30, 1998. Yahoo Inc. has lost money every quarter except the first and third quarters of this year, where it registered earnings of $0.05 and $0.015 per share respectively but mingled with a $0.41 per-share loss in the second quarter--its largest quarterly loss yet. Netscape has managed virtual breakeven this year after a whopping $1.02 per-share loss in the fourth quarter of 1997.

Yet these stocks have been routinely bid up 20% to 40% in a single day recently. Moreover, the Wall Street Journal reported Wednesday that insiders at companies that do business on the Internet have been selling shares, taking advantage of their "logic-defying ascent." To underscore this point, the WSJ also reports that these insiders were willing to hold onto these stocks throughout this summer's volatile plunge, but now there is a marked change in their behavior. Insiders typically sell when they feel their stock is fully valued or overvalued, and analysts typically do not attempt to go contrary to insiders since they tend to be correct.

Although investors are arguably betting on the future--a proxy on the future success of the many companies on the Internet that have yet to emerge, in much the same way one might have been on the future of electricity or the assembly line in the 1920s by buying the electric and auto companies then available--it is difficult to justify the apparent discounting of the "hereafter," as Alan Greenspan recently described the U.S. stock market before its 1997 and 1998 plunges, by sending today's Internet stocks to above $200 a share.

"From a fundamental analysis standpoint," said Bill Burhnam, electronic-commerce analyst at Credit Suisse First Boston Corp. in Wednesday's Wall Street Journal, "it's a baffling trend, and it's indicative a lot of [investors] don't know what they're doing."

Intensely emotional speculation has marked the impending top of many an investment bull market, and it is possible that the Internet craze is the modern-day version of Holland's Tulipmania nearly four centuries ago. In most manias, Frederick Allen's observation is ostensibly proven before the whole thing collapses. Again describing the 1929 bull market, Allen says:

"Two steps up, one step down, and two steps up again--that was how the market went. If you sold, you only had to wait for the next crash (they came every few months) and buy again. And there was really no reason to sell at all: you were bound to win in the end if your stock was sound. The really wise man, it appeared, was he who 'bought and held on'."

Wise, that is, until it's all over. While we acknowledge that if there's a play that makes money--no matter how crazy or unsound the reason it is occurring--then it can be taken by aggressive speculators, the risks are nonetheless tremendous, the stakes high, and history is not on the side of those banking on the old bull market remaining alive indefinitely or on Internet stocks justifying their current lofty price levels above $200 per share by raking in huge earnings any time soon. In fact, our daily research products, Key Markets Daily Forecast and Telephone Hotline/Web Update, offer plenty of speculative ventures for those deciding to take the risk on short-term trading in every market environment.

Our monthly market letter, The Global Market Strategist, however, offers a longer-term perspective for those striving to increase portfolio size but still manage risk. At the seat of our strategy has been recommendations for 1998 to diversify, with only portions of portfolios in U.S. and European stocks after we successfully avoided the plunge into this year's 4-year cycle low last month.

For 1999, diversification will not only be even more important than in 1998. It will be imperative.

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