Thinking about Prices II Jude Wanniski July 31, 2000

Watching NASDAQ’s 10% slide last week got me thinking about “prices” again. One of the things I did years ago that has yielded unexpected benefits was to diversity my portfolio among different money managers, now numbering four, each with a different perspective and style. As a result, I’m almost always long in one stock with one manager and short the same stock with another -- watching curiously to see which gets it right over a track of time. In the last two years, I’ve almost always been long and short Amazon.com, for example, but I can see it suits the styles of the different managers. Over time, I may actually make money on both. The Amazon shortseller jumps in and out -- gloating these days over Jeff Bezos’s trials and tribs. The patient Amazon fan has been there for a long time and never budges, still sure that Bezos is more often right than wrong and that in due time there will be a move to a high plateau where a perpetual Amazon cash cow will reside.

It is also of interest to note that of my four managers, all of whom are clients of Polyconomics, none is a skeptic about the New Economy and its enormous potential. Warren Buffett didn’t get it and neither does Jack Welch of GE, who recently told Maureen Dowd of the NYTimes that e-commerce is just another promising technology -- along the lines of the telephone, the telegraph and television. As smart as these fellows are, they make me think of the industrialists of the 19th century who were bemused by Andrew Carnegie for scrapping perfectly good steel mills that were still profitable -- deciding to leap ahead to finance the new processes that had been invented. It was the slow-motion equivalent of an Internet play in today’s world. Even Joseph Schumpeter’s concept of “creative destruction” of the capitalist marketplace does not approach the rapidity by which the dot.coms have to reinvent themselves in order to stay ahead of the competition. In a perfectly competitive world, remember, there is almost no difference in price, almost no reason why one would invest in Acme Widget over National Widget when their widgets were the same price. If Acme suddenly hired a better manager who could squeeze another nickel out of production for the bottom line, the shares would be bid up, but only a teeny weeny bit. P/E ratios behave themselves.

In my first visits to Moscow, beginning in 1983, I was surprised and amused to have discussions with socialist policymakers who thought prices of widgets in the U.S. were determined by managers adding up the costs of producing them, then adding an amount as the profit for the capitalist. They had a hard time understanding that the marketplace determines the price and the managers try and figure out how to make a profit from that price. The dollar price of a share of Acme.com can and must go out of sight when it first shows up in the market with an amazing new widget. It is incorrect to look back now and snicker at the marketplace running Amazon and E-Bay into the stratosphere, with no earthly possibility that they could ever produce positive returns -- given the likelihood of the competition they would encounter in the future. The price had to go into the stratosphere to signal likely competitors that there would be a bundle of money to be made by emulating the new kids on the block. It is hard to imagine the shares of Amazon.com rising at a stately pace to where they are now, with no booms and busts along the way. There would have been none of the competition invited by the boom and the great potential of what it was that Bezos had discovered would take much, much longer to be realized. As it is, like Carnegie, he himself knows he only can stay ahead of those hot on his heels by scrapping his old mills as better stuff appears -- and if he makes fewer mistakes in judgement, he will wind up #1 cash cow in a field of three atop that plateau, a la GM, Ford, and Chrysler.

The numbers we saw in March, at the dizzy peak of the dot.coms, were absolutely real, in the sense that they provided a glimpse of what the market saw as the potential of those then in the running -- a reasonable market cap worth shooting for. Those who saw only an irrational “bubble” were usually those who had been warning of an irrational bubble all during the boom -- like kibitzers who urge you to take your winnings off the crap table after you made your first pass or two. Those who got caught in the downdraft when April tax-selling broke the dizzy momentum were more like the players who were trying to break the bank with the house’s money. In retrospect, they were all part of a market that was testing the limits of the realistic capital needs of the New Economy. The wave of tax selling to meet unexpected tax liabilities for short-term capital gains was, in a way, the Old Economy tripping up the New with its insistence on sober, patient capital embodied in the 12-month holding period.

My earliest image of the dot.coms still holds, I think. They sit close to the end of a bullwhip, snapping up and down because the market has to make rapid readjustments in its estimate of realistic capital needs. The market must be realistic, after all. If it were not, we would have to replace it with wise men, as the Russians did, giving their best men and women seats in the Kremlin with the power to set prices and allocate precious capital extracted from the working masses. What constitutes realism? There are a whole series of considerations: What will the tax system look like over the next several years, realistically, as the infant industry looks for fresh capital in this, its most important growth stage? Will the economic pressures that create Federal Reserve interest-rate policy -- through the Old Economy regional banks -- work at slowing down e-commerce? What will be the risks of new rules and regulations associated with patents and copyright law and antitrust law and privacy considerations? What next can we expect from the Internet terrorists bent on finding ways to poke holes in this new, relatively fragile connectivity that wants to move faster than some members of the global body politic think desirable? Is it time to re-read the message of the Unabomber?

These are the kinds of questions we raise when we think about the prices of things in general and financial assets in particular. One of my repeated themes for the last decade, since the Berlin Wall came down, was that we were going to get an enormous “peace dividend.” Not that “money” devoted to war would be saved, but that the best political minds we have would be liberated from wartime imperatives and thus become available to clean up the mess at home. It was comforting yesterday to hear Dick Cheney explain why he spoke favorably two years ago of OPEC’s decision to cut back oil production so the oil price would rise. With five years running the world’s premier oil-service company, here was the former Pentagon chief tutoring the press on prices and capital: Unless the price of oil were to rise from its then level of $10 a barrel, it would not attract capital for exploration and development! In that moment, Cheney seemed the embodiment of my metaphorical peace dividend. He may not yet see the source of the oil issue in the Fed’s 1997 monetary deflation, but as long as he can see the connection between prices and capital, he will be able to learn the rest. To have this kind of man close to the next President would clearly mitigate risks to both the New Economy and the Old.