Bubble update

Enrique Diaz-Alvarez enrique at anise.ee.cornell.edu
Wed Jan 6 18:50:47 PST 1999


First, FunFacts about Alan's Tulip Market(TM)

-> The market value of Microsucks is larger than Spain's GDP.

-> Remember when Doug joked about the day when the NASDAQ would sell at a price/earnings ratio of 100? Guess what.

-> scamazon.com's market value is almost twice the total value of all the books sold in the US every year. Borders just warned; it's hard to make money when the competition gives the stuff away at 70 cents on the dollar.

-> AOL's market value is $6,000 per subscriber

-> Yahoo's market value is $45 million/employee. For its sales to catch up to its market value, they would have to grow 50% a year until the year 2013.

Finally, last time I brought this up, there wasn't much interest, but I'll try one more time. What do y'all think?

Piling up debt to power the rise in shares

<Picture>

by ANDREW SMITHERS Chairman of fund manager advisers Smithers & Co

One of the more perverse pleasures in life is looking at economic statistics. The rewards

lie in finding that "what everyone knows" is so often far from the case. A current

example of this is the widespread belief that the US stock market is being driven

forward by individual Americans through their investment in mutual funds.

Every quarter the Federal Reserve publishes statistics on the flow of funds in the US. It

has just published the data for the third quarter of 1998. This not only shows that

individuals are massive sellers, but that mutual funds also sold shares.

The big buyers who are keeping the stock market up, are US companies, who bought

at an annual rate of $222 billion (£135 billion). Some of these purchases are companies

buying in their own shares and others are the result of takeovers.

The amount companies spend on buying shares is more than twice as much as their

profits, after they have paid out dividends. This means that the equity capital of US

companies has actually been shrinking.

Not only is the expansion of US business being financed entirely with debt, but the

equity base on which this debt pyramid is being built is actually shrinking, even though

US companies are already heavily in debt. Half the capital they need is now borrowed

and if they continue to buy shares, the situation will rapidly get worse. It seems,

therefore, that if Wall Street is not to crash, US companies must be increasingly

debt-ridden.

This, of course, could go on for some time, as the general attitude in America is that

debt is good for you and savings are for wimps. There are, however, some signs of

nervousness around in the bond market, where the difference between the cost of

borrowing by the government and by companies has shot up. Nonetheless, companies

will continue to buy shares if they can. This pushes up share prices and makes senior

executives richer through their share options schemes.

As US corporations get increasingly into debt and bond markets are less willing to help

out, they have turned to the banks. One result of all this is that US money supply is

racing ahead and past experience warns that this will eventually lead to inflation.

The Federal Reserve, however, is much more worried that the economy will be too

weak than too strong. It has cut interest rates three times recently, in spite of the fact

that money supply is galloping away. This is because the Fed is worried about the stock

market and wants to prevent it falling. It fears that consumers will take fright if the

market falls and that this will quickly bring on a nasty recession. The problem with the

Fed's policy is that keeping the stock market up requires a rapid build-up of debt and

the more debt builds up, the more difficult it will be to climb out of the next recession.

Enrique



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