Outlook for the U.S. stock markets and interest rates
1999 Stock Outlook: Review and Update
Outlook for Ex-Soviet Equities
Outlook for Small- and Microcap Sectors
Outlook for Initial Public Offerings
Outlook for Global Stock Markets
Outlook for the Internet Market
Outlook for The Internet Market
Odi et amo
I hate and I love -- a famous line from Catullus that pretty well sums up the way I feel toward this business right now.
Just as the 1999 Forecast Issue was going to press, America Online dropped a bombshell on the business by announcing it was purchasing Netscape Communications Corp. in a US$4.2 billion stock deal. I'd heard rumblings about this some time before but, sentimentalist that I am, could hardly believe it. These were the guys I've referred to as "the Vandals from Vienna, VA" eating the original Internet company.
Actually, it wasn't the first
dance between Netscape and AOL. A few years ago, AOL shopped
Netscape to provide its Web browser, and to its credit pursued
the deal until Microsoft, in its best Mephistophelean anything-to-please
mode, got AOL to use Internet Explorer instead.
Fast-forward: As Microsoft wallows in the mire of an antitrust suit brought by the U.S. Department of Justice, America Online buys one of its fiercest enemies -- and brings Sun Microsystems, Bill Gates' own personal Kryptonite, in on the deal.
I'm not sure it's bad for Microsoft,
actually. The deal will give AOL, already the runaway leader
in consumer online services with upwards of 14 million members,
ownership of the two busiest sites on the Internet -- its own
and Netscape's Netcenter. (The other two titans are Yahoo and
Microsoft's own.) With "portals" among the hottest
items in a very overheated Internet stock market, no one watching
the Justice suit against Microsoft can ignore this.
Nor can anyone ignore Sun Microsystems' involvement. Outspoken Sun chief executive Scott McNealy has never missed a chance to voice his loathing of Microsoft. Also, the nscp-Netscape-Sun deal came right on the heels of a court victory for Sun against Microsoft, in which the court upheld Sun's charge that Microsoft had attempted to sabotage Sun's Java programming language.
As it stands now, Sun will help develop, market, and distribute Netscape's server software -- the suite of applications on which Netscape was banking its future now that 1996's "browser war" with Microsoft had fallen into stalemate at best. Netscape CEO Jim Barksdale's future role is unknown at this time, but having him and McNealy under the same flag will certainly not help Bill Gates sleep nights.
All this in the two weeks before the Forecast Issue began its journey to you. Who needs soap operas or John Le Carré
Odi et amo.
1999 -- More mania, or meltdown?
As an astute follower of equity markets, you may have noticed that Internet stocks have gotten a trifle overheated. I mean, really. Again, in just the weeks leading up to the publication of this issue, some Net stocks have gone way past the moon. Amazon.com announces a 3-for-1 stock split, and its price shoots past US$200. Recent IPO Ebay joins Amazon in the US$200-plus club.
What does Amazon do? IT SELLS
BOOKS. Okay, they're adding videos and other stuff you can get
at the Wal-Mart, too. Big hairy deal. For this, Amazon merits
a US$11.4 billion market cap? Microsoft's market cap now stands
at US$319 billion, for a proven name that most still consider
a growth stock. (We'll see what cross-platform computing and
the U.S. government have to say about that...)
It's instructive to note that the rocket fuel for Amazon, Ebay, and some other lunatic Internet stocks is overwhelmingly retail stock trade -- that is, the small investor. Average trades of these stocks are on the level of a few hundred shares -- not the kind of block trades that characterize institutional investment. A lot of guys are out there buying boats based on the killing they've made from the Amazons in the market. And more power to 'em!
So when does the bubble burst?
I want to draw some lines between what I see as the four types of Internet stocks. I'll rank them in descending order of lunacy.
1. The bubble stocks: Amazon, Ebay, and their ilk. Not only are these retail stocks in terms of their principal holders -- they also tend to be involved in retail. Take a deep breath and think about the K-Tel story: Schlocky music outlet adds a ".com" to its name, zooms into orbit, gets beaten back down -- and now faces de-listing. Forget buying that boat. Anyone who bought K-Tel near its highs, especially on margin, is looking at a second mortgage or a diet of ramen noodles. That won't happen to Amazon -- I've met with them, and they're a canny bunch with one of the great new-media brand names. But retail is retail, and Americans only buy so many books. Besides, Barnes & Noble, who just picked up powerhouse book wholesaler Ingram, can sell books on the Net just as easily, and can leverage its brick-and-mortar superstores as well. Internet cafes serving lattes at Barnes & Noble, with cushy Net terminals configured for B&N.com? Bet on it. But for heaven's sake, don't buy Amazon at these levels.
2. Internet coattail stocks:
I recommended one of these a few months back, and I'm sticking
by it even though it's trading in a dull range right now. That
stock would be Seattle FilmWorks (FOTO-NASDAQ), a retail film
processor with a good record of taking advantage of digital technology.
You can send your snapshots to FOTO and within a few days receive
an email giving you password-protected access to an FTP server
from which you can download the photos. They will burn your pics
onto a CD. Oh yeah, they also do prints on paper. I like FOTO
because it is well-positioned to take advantage of Net technology
even more fully than it has. It's not seen as an "Internet
stock" so its p/e is quite sane -- around 7 at this writing.
FOTO is what I call an Internet coattail stock: Ready to use
the technology, but not breathing the ether that the Amazons
suck in daily. The downside is that coattail companies may or
may not benefit from their position or from the current Net mania.
3. Real new media: Yahoo is the premier example here, but any of the leading portal sites fit the description. These are the guys who "get it" -- the Internet is not a mall without walls, but a medium just like print, radio, and TV. Look at the deal between search engine/portal Infoseek and Disney. Where content meets eyeballs, money is made. I like these stocks, but so does everyone else, and most are hideously overvalued. But in the long term, a few might pay off handsomely. More on this below.
4. Infrastructure: Cisco. MCI/WorldCom. Lucent. The relatively unsexy crew that puts all the wires and boxes in place that allow bubble Internet companies to make their froth. The more exasperated I get with the bubble stocks, the more I like the infrastructure companies. Granted, it's buying boring blue chips instead of speculating on moonshot IPOs. But US$10,000 in Cisco might be US$12,000 next fall, whereas the same amount in K-Tel would come to...Enough said?
Again, so when does the bubble burst?
Ask Nostradamus. A lot of smart people -- some of whom I have the pleasure of knowing and cribbing from -- have been predicting the Big Pop for a year. It hasn't popped yet. Even in the bloodbath that began last summer and may now be over, a lot of really vaporous Net stocks held up pretty well.
Check my list above. If you want long-term value, the infrastructure stocks are sound. Flashy companies will come and go, but the Internet will grow -- and every bit and byte sent on the Net needs their equipment. As a sound long-term investment, I like Cisco, especially on any dips.
Real new media companies -- the portal stocks -- are overvalued but worth a look in the event of an overall market dip, if these stocks take part. Yahoo! is the big name, and not to be ignored, but consider Inktomi, Lycos, and Infoseek.
My coattail stocks -- Seattle FilmWorks, and others I'm researching at this time -- are vulnerable to the movement of the markets as a whole. This crew is a little like investing in biotechs, but without as much downside risk. At worst, these companies will trade in a narrow range. A few will break out. As a group, these are my favorite growth stocks for 1999. They are not associated with the great Internet bubble, so will not suffer if the bubble bursts. At the same time, they are cheaply valued relative to the overall market, and a few will be big winners. Watch FOTO, and keep up with Taipan and taipanonline.com for future recommendations in the coattail Net stock zone.
That bandwidth thing
The Internet will become TV.
Like it or not. I don't like it myself -- I've been on and around the Net since the early 1980s, and one of my favorite things about it is its total lack of resemblance to Ally McBeal or whatever miserable dreck you choose as metonymy for the worst broadcast TV has to offer. But the Net will become more like TV. Here's why.
You can't watch the Super Bowl on the Internet -- at least, not very well -- because there isn't enough bandwidth to deliver high-quality multimedia. It's a fine medium for typing. With some fancy compression, such as that provided by RealNetworks (my favorite stock of last year, did quite well, but forget 'em now), you can see grainy, jerky video and sound quality I wouldn't accept from a roaming analog cell phone.
Bandwidth equals big bucks. I know I've been harping on this for two years now, but it's beginning to happen. The MCI/WorldCom deal is one sign. AT&T plus cable provider TCI is another. Broadband Internet is starting to trickle into test markets around the US, and unlike the abortive attempts at interactive TV a few years back, it's not going away.
There are two technologies that are the real contenders for broadband consumer Internet access. (For our purposes, I'll lump the home-office and small-business markets into the term "consumer." Well, there are actually three, but you can forget about satellite dishes. Take my word for it. The two that count are cable and xDSL.
Cable in the cradle
You already know cable -- the snaky black coaxial cord that delivers TV to millions of American homes. I live within sight of Baltimore's main TV broadcast towers. I can see their air traffic warning lights flashing through the leafless trees as I type this. But I still have cable. Cable has market penetration from the poshest 'burbs to the trailer park. It offers torrents of bandwidth -- enough to watch the Super Bowl over TCP/IP, also known as the Internet. It also has problems.
First, the current cable infrastructure is a largely one-way network: It feeds, you watch. It will take billions of dollars in capital investment to install the Internet-type hardware needed to make cable a two-way network. See why I like those boring infrastructure stocks? With the entry of an AT&T into the market, such a conversion might just happen -- but not without lots of cost on building and marketing.
Second, cable Internet is inherently insecure and suffers from service degradation under heavy loads. Cable shares resources from a central location. If you're the only one in your ZIP code with cable Internet, you'll have more bandwidth than you can possibly use. In a crowded city environment, each new user on a central cable unit will sap bandwidth from his neighbors.
I predict cable Internet will find a niche among relatively low-rent customers. Nothing personal, folks -- if I lived a mile further north, I'd have Baltimore County's Comcast instead of Baltimore City's TCI, and cable Net would be an option. I'd give it a test drive. But until the security and bandwidth-degradation problems of cable are ironed out, I believe it's best suited for the WebTV market.
DSL, too soon to tell?
The competing technology is Digital Subscriber Line -- most commonly Asymmetrical Digital Subscriber Line (ADSL) but generally abbreviated xDSL or just DSL because there are several flavors. I love DSL, even though it's slower and more expensive than cable Internet. Stupid? No. DSL offers the security and reliability of a circuit-switched network (that is to say, the phone) to deliver high-speed packet data (that is, the Internet). DSL works over existing copper telephone lines -- lines that are being ripped up and replaced with fiber-optic at the rate of miles a day, but which won't go away soon.
Also, no one in his right mind needs that kind of bandwidth right now. Maybe on the accursed day when the Net becomes TV -- more on that in a moment. But not now. I've seen DSL at work, and it makes me curse dial-up networking every time I have to use a modem.
There are problems with DSL. First, it costs more. I cannot provide meaningful comparisons, because both cable and DSL are more or less in beta even in the more advanced US markets such as Silicon Valley, Northern Virginia, and Seattle. Then there is the problem of "the last mile" -- the notorious bottleneck that crimps broadband Internet for most of our population. In the case of DSL, signals degrade over distance, so that customers more than a few miles from a central switching station are unable to get DSL access.
Counter-point: Higher cost does not equal a losing prospect. Two years ago, when flat-rate was all the rage, I predicted a tiered market for Internet access: gold-plated, reliable accounts at a premium price, and buffet service for US$19.95. It's here. The same applies to broadband Internet. Small business and telecommuters demand reliability. They have the means to buy it. Given the choice of current technology, they will choose DSL.
Counter-point No. 2: The residents of Arthur, Nebraska, might have to wait a while for DSL access, because of the signal-degradation problem. But most Net users live in or near large cities...in fact, about 75% of the U.S. population is classified as urban. Most are not far from telephone switching stations, and so not out of the reach of DSL.
My colleague James Passin has recommended Israeli DSL hardware maker Orckit (ORCTF-NASDAQ) as a play on DSL, and I concur. It's a medium-term investment, in my opinion, because DSL has yet to roll out on a large scale. But Orckit appears to have low research and production costs, and has inked some valuable deals with American companies. Within three years, I predict DSL will dominate the more lucrative home-office and small-business segments of the Internet access market, and companies like Orckit will benefit.
What was that about TV, anyway?
So how will the Internet become more like TV? And who will make a killing? And why does it annoy me so much?
Once all this broadband stuff really gets going (around 2002, I believe), media companies, old or new, will be able to pump all kinds of glitzy stuff onto your computer screen just as well as it's poured onto your TV screen. And just as expensively. Mom and Pop's static Web page with pictures of the kids and dogs cost next to nothing. Yahoo's costs millions -- and makes millions. Get the picture?
Here's Bill's Law of the future of the Internet:
Production costs of successful Web sites will increase in direct proportion to the available bandwidth.
And bandwidth is about to explode.
So keep an eye on those overvalued new-media (aka portal) stocks. I am. The ones with the eyeballs -- and the deals like the one Infoseek made with Disney -- will collect more content, more revenue. Everything else will wither on the vine. Even though all of these Net stocks will take a well-deserved beating at some time, a select few will eventually grow into their valuations as the media giants of the early 21st century.
Millennium Myths
At midnight on January 1st, 2000, all hell will break loose.
Banks will seize up. Forget using the ATM or your debit card. Forget credit cards and checks, for that matter -- the computerized clearinghouses for both will shut down. The North American power grid will be thrown into chaos, causing patchwork blackouts plunging millions into darkness at the coldest, darkest time of year.
Fires and civil chaos will make the '92 Los Angeles riots look like a Boy Scout jamboree. The crippled U.S. government will declare martial law, but whole sections of the military will have their hands full with the threat of accidental nuclear launches, disabled weapons systems, and planes that won't fly.
Speaking of planes, I hope you aren't planning on traveling that weekend (January 1, 2000 is a Saturday). The people stuck in airport terminals will be the lucky ones. Those who actually get airborne will face the grim possibility of fiery death as airliners' navigational computers fail and air-traffic control systems, likewise crippled, are unable to help them negotiate the wintry night.
Never mind driving, either, unless you own an antique car. Anything with modern ignition-control and fuel-injection systems will sputter and die as embedded chips blunder. If you can get the thing to run, city and suburban traffic will become a combat zone as panicked masses flee burning urban centers through traffic lights that blink yellow, if they work at all. The police, already overwhelmed by mass looting and mayhem, will be of no help -- and you won't be able to call them, anyway.
How do I know all this?
I read it in The Weekly World News.
If you haven't had the pleasure of reading the WWN, it's a supermarket tabloid of the most lurid sort, available on the finest gray newsprint and normally sporting cover stories about three-headed mutant alien babies conceived on orbiting spaceships, or Elvis being sighted at a 7-Eleven in Winnemucca, Nevada. On September 15, 1998 their cover read:
THE COMPUTER CRASH OF THE MILLENNIUM!
I would assume the latter to be true, since digital computers have only existed since the 1940s.
Here's a news flash: Computers are ALWAYS breaking down. How many times has your PC crashed in the past few months? (If you own a Macintosh, how many times has it crashed today?) Mainframes, minicomputers, servers and routers -- they all get the flu from time to time. Hence Bill's 1st Law of Computing:
The more you know about computers, the more astonished you are that they ever work at all.
None of this is to say that Y2K is a myth. It is a problem -- for legacy systems especially, but ordinary PCs will likely have a hiccup or two. The creepy thing about Y2K is not that it will break computers, which already spend so much of the time broken. It's that it could break so many of them at one time.
The truly creepy thing, though, is the FUD factor -- fear, uncertainty, and doubt spread by the media about the Y2K problem. Some of the stuff coming from "reputable" news sources is only slightly less alarmist than the cover story from the Weekly World News. And unlike stories about three-headed Elvis babies, millions of people believe it.
Apocalypse now
And the FUD factor is already at work. The U.S. Federal Reserve has ordered an extra US$50 billion in currency reserves to be available by September, 1999. That's in case millions of people rush the ATMs before they break down, stockpiling cash for an all-cash economy.
Truth be told, I'll be one of them. I intend to sock away a few greenbacks, just in case. Just enough to fuel the car and buy come groceries until the ATM and debit card work again -- if, in fact, they ever break down. And I will fuel the car, because the embedded chips in my new sports car don't know 2000 from 1066. They just know how to breathe air and burn gas, thousands of times per minute. That's only the beginning of the huge Y2K mythology that fuels the real Y2K problem.
FUD you
I fully believe FUD is the real problem. When even a Weekly World News-level citizen is being scared by stories of coming computer apocalypse, the Y2K economic problem is in danger of becoming a self-fulfilling prophecy. And I view Y2K as an economic problem, not a technical crisis. Consider this:
Brain drain. Corporate IT budgets are already being diverted to fix this thing. It's good news for a few -- such as semi-retired COBOL programmers who are contracted at top dollar to scan and fix the millions of lines of code. A lot of guys will be able to buy vacation houses, sports cars and boats from their personal Y2K windfall. But overall, fixing Y2K will continue to drain resources from really productive work -- upgrading networks, improving applications, speeding databases. A dollar is a dollar, but each buck spent on Y2K will slow down progress in the industry for the next four to six quarters.
Litigation! The US government has taken some steps to limit liability in Y2K-related cases. Although I'm a firm libertarian, I think it needs to take more. The alternative is a decade or more of Jarndyce v. Jarndyce writ large over the U.S. economy. Compared to the diversion of a few billion in IT funds, this would be pissing away money on a cosmic scale. And it still may happen. Remember, the United States is the country where a septuagenarian McDonalds customer can win a big settlement by pretending not to have known that hot coffee can scald. It's not a big leap from that one case to thousands by individuals and corporations who will profess never to have heard of a computer bug that's saturated the press for three years.
Sheer nuttiness. Who know how investors will behave as the millennial New Year draws near? It might not cause a ripple. Or there might be a flight to commodities, hard money...who knows what. High priests of the Dismal Science can't predict investor psychology in normal times, and the looming End of the World As We Know It is definitely not a normal time. That's the Uncertainty part of FUD, and one certain thing is that markets hate uncertainty. If equity markets are already weak in latter 1999, Y2K hysteria could turn Winnie the Pooh into a raging grizzly.
C'mon, c'mon now tech me baby
What are the technical foundations of this whole (potential) mess, anyway? Here's the concept in a nutshell.
Back in the Stone Age of computing (the late 1960s and early '70s), digital machines were underpowered little Yugos. I have more processing power in my ThinkPad than the Apollo missions used to land on the moon. So, like first-time homeowners trying to save closet space, programmers of the day cropped the "19" from "1968." It made sense at the time. Moore's Law was brand-new, the skies were blue, and who in hell would be using these kludgy old machines and programs when the "19" became "20"? Impossible.
Whoops! Like most technical types, the FORTRAN and COBOL slaves failed to account for corporate and government stinginess. The CEO might get an on-call Gulfstream, or the agency a teak-lined conference room, but not a penny to upgrade those old ("legacy," in industry parlance) systems. They weren't broke, so why fix 'em?
A lot of the programs written that contain Y2K flaws weren't the shrink-wrapped products you get at CompUSA. Rather, they were custom-fitted applications for which clients paid a ton of money and then forgot about, as long as they kept running, which they mostly did. Over time, backups were lost -- if they were ever made in the first place. Programmers retired. Software companies that supplied the systems went out of business.
So now we're faced with the digital equivalent of cataloguing a dotty and now-deceased aunt's attic. No one knows what a lot of this stuff is, but some of it might be important, so sort carefully...
Cash for chaos?
Forget the riots and plane crashes and all that, and brace yourself for the really bad news, from a Taipan's perspective. Where do you, as an individual investor, make money from Y2K?
I don't see much upside. I believe any windfalls for companies able to offer Y2K fixes -- Unisys is one example -- are already built into stock prices. Because there is no one Y2K bug -- instead, there are millions, each different, scattered amid millions of lines of legacy code -- I do not see how any previously unheard-of company is going to arrive with a magic bullet and send its valuation through the roof.
Even companies that can benefit from total systems replacement -- the "rip it and replace it" approach to Y2K -- are already highly valued, and the markets are well aware of any benefit they may receive from Y2K-fix spending. I'm talking about companies like Dell, IBM, and other hardware makers, plus software powers like Oracle, PeopleSoft, and such.
Y2K is not a secret. To take the "buy on rumor, sell on fact" axiom one step further, Y2K has entered the realm of clichÈ.
Somewhere, beyond the sea
So far, I've focused on the Y2K problem in North America, the U.S. in particular. That's for two reasons. First, U.S./Canada represent the largest and most computerized economy in the world, and whither these two, so the rest of the world. Second, most of my contacts are in North America. But here are a few insights into the ROW, as we Americans condescendingly call it.
In Japan and other advanced East Asian economies, Y2K might actually be a good thing. Even more than North American systems, Asian computers are built on heaps and heaps of customized legacy code. This is inefficient, hindering information exchange on the west side of the Pacific Rim. Y2K is a good excuse for housecleaning, if already-crippled governments and economies can muster the will and resources to get the job done. We'll see.
Europe faces a much brighter Y2K scenario. I have learned that many European systems -- both public and private -- are getting Y2K fixes along with the necessary updates to convert to the euro. Good timing, and a good sign for European business overall. I believe European financial institutions in particular will be well-armed against the day of Y2K.
And finally, to speak of financial institutions, the U.S. Securities and Exchange Commission has been very stringent in Y2K compliance rules. If the markets take a Y2K tank in late 1999, it will be because of investor panic, not because the system is unprepared.
Coda
So you've come this far, and don't believe a word I've said to assuage Y2K panic. As an upstanding survivalist, what will you need to survive the catastrophe that WILL occur with the millennium, no matter what urban-living-softened pundits like Bill Sanders say? Fear not: I was raised in truck-driving, camo-wearing country, and so humbly offer the following:
1. Rural land, distant from major transportation arteries (to avoid marauding bands), with adequate shelter, game, arable land, timber supply, and a free-flowing spring or hand well as a source of fresh water
2. Well-maintained firearms, with ample ammunition stores. A reload kit will be useful. As a basic store, I recommend a quality deer rifle for subsistence hunting, shotgun for hunting fowl and for defense, and at least one handgun for defense. Fully automatic weapons for defense may be useful, but are wasteful of ammo
3. Root cellar (refrigeration will be impossible when the power grid fails) stocked with simple, nutritious foods such as potatoes and canned goods; canning supplies should the crisis outlast the 2000 growing season. Basic gardening tools (not mechanized). Livestock -- hogs and chickens are most efficient
4. Generator and fuel, plus non-electric light sources (kerosene lamps are a good choice); woodstove; stockpile firewood (especially hardwoods such as oak or hickory) as often as possible
5. Basic medical supplies: bandages, analgesics, antiseptics, antibiotics
6. Two-way radio, full-spectrum scanner; rechargeable batteries
7. Cash and/or precious metals, secured in safe or buried
Hey, I already have most of this stuff. Good luck! I WILL see you next year.