Investors might well be leery of advice from a man who predicted back in 1999 that the Dow Jones industrial average -- which plunged below 8,000 in late July -- would hit 36,000 by 2004. But that hasn’t stopped economist Kevin Hassett from hauling out his Ouija board one more time. A resident scholar at the American Enterprise Institute for Public Policy Research, Hassett has just published a new book, Bubbleology: The New Science of Stock Market Winners and Losers.
Was the dot-com frenzy a classic financial bubble, as most economists and day-traders-turned-taxi-drivers would contend? Hassett isn’t so sure. Defining a bubble as a period when asset prices suddenly soar for an irrational reason and then collapse, the author posits, “Individual human behavior that has been observed in many apparent manias may well be rational under the circumstances, even if the result of that behavior -- wild swings in prices -- appears not to be.”
So irrational exuberance may not have been? In his investigation, the author used data from 1999, when the Nasdaq was riding high, to compare companies listed on the Dow Jones composite Internet index and the Hambrecht & Quist Group Internet index with the stocks in the DJIA. Hassett found the five biggest one-day price movements for each stock during the year and examined the relevant news on those days. He distinguished between “high-quality” news, which he defines as “material events that could have a large effect on the long-run prospects of firms,” and “low-quality” news, which contains “news stories of more questionable relevance.” Hassett tosses new product rollouts and joint ventures into the latter category as well, which may be misleading. After all, some new products can significantly alter a company’s long-term prospects. Hassett argues that such results are less tangible (and much more difficult to predict). According to his research, 55 percent of the Dow industrials saw their share prices move on high-quality news such as an earnings announcement.
The Internet stocks, on the other hand, hardly budged on such news; instead, 60 percent of them reacted to low-quality news. This, Hassett writes, is “a strong signal that the market was behaving oddly.” Investors behaved oddly, too, he argues, but not irrationally.
Hassett approvingly cites the 1983 study of bubbles by two MIT economists, Olivier Blanchard and Mark Watson. They found, writes Hassett, that “boom and bust behavior might be consistent with the actions of rational participants. If humans can always expect a new genera- tion of suckers to buy the asset, a market with fully rational investors could produce a bubble.” In other words, there’s nothing foolish about the greater fool theory.
Hassett maintains that a prudent New Economy investor could have separated the EBays from the Globe.coms by investing in Internet stocks that moved on substantive reports, while shunning those that jumped on superficial developments. “The few good Internet firms that increased on solid news returned so much that an equal investment in each firm listed on the two Internet indexes [the Dow Jones composite Internet index and the H&Q index] made money between January 1999 and May 2001. A stake in all Internet firms increased by a healthy 41 percent over that two-year period.” Of course, since May 2001 the DJ composite Internet index is down nearly 70 percent.
In the end, Hassett concludes, the dot-com boom was a bubble after all -- though “not as fierce a beast as might have been expected from listening to news accounts.” Bubbles, he writes, are fueled not by real news but by the vaguest of expectations: “The Internet involved a new technology at the frontier of our understanding, where ambiguity was highest. The Internet would obviously change everybody’s life, but nobody knew exactly how, or which firms would profit the most from the new world order.”
Hassett, who co- authored Dow 36,000: The New Strategy for Profiting from the Coming Rise in the Stock Market with James Glassman, has this advice for postbubble investors: “Wall Street has never ignored a chance to make a quick profit and, accordingly, new offerings appear in unusually good times that have unusually bleak prospects. Don’t buy them.”
As for his famous prediction, he writes: “During the two years that were dominated by the collapse of high-tech shares . . . the Old Economy ‘36er stocks’” -- a group that includes Coca-Cola Co., General Electric Co., Microsoft Corp. and Campbell Soup Co. -- “identified by my co-author James Glassman and myself in Dow 36,000, continued their climb upward, outperforming the tech-influenced S&P 500 by almost 30 percent.”
