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[investor_007]

Manifesto for a New Market: Part 1
By James J. Cramer

4/6/00 6:58 AM ET



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When you get together with a group of seasoned managers, you get to hear first-hand the contempt that the professionals have for this market.

First, understand that far from saying the standard "nobody understands this wacky market," these managers understand it all too well. They have seen pretty much everything at one time or another, and they know in their hearts that the market is, ultimately, just a popularity contest short-term and a business-valuation method long-term.

What they didn`t know was the definition of "short-term." They didn`t know that in the short-term the popularity contest could be so vicious -- and so rewarding for the pure-oxygen optimists -- that it would put their digging-in-the-heels fundamental work to shame.

So perhaps it is a good moment to talk about what it is that so irritates the professionals about this market.

First, the professionals truly believe in the notion that they are investing in businesses not stocks. I like that notion. I used to believe in it. It made me money for a long time. When it is right again, I will switch back to it because I am pretty good at it. It`s what I started with, how I was honed, and it makes a ton of sense to me.


Somewhere along the line, however, perhaps because I was a journalist in a previous life, perhaps because I am by nature a nihilist at work who leaves the beliefs at home, I came to view the market from a different perspective. I came to view it as the logical intersection of the following tenets, which I hold to be self-evident:

Supply can be manipulated to spur demand.
Demand determines which stocks go up.
Never underestimate the power of the Wall Street promotion-mutual-fund-affection machine.
Everybody in the end is driven to find the next Microsoft (MSFT:Nasdaq - news - boards), Cisco (CSCO:Nasdaq - news - boards) and Intel (INTC:Nasdaq - news - boards) because of how much money those stocks have made, regardless of the possibility that their choices won`t pan out over the long term.
To sell is wrong; to buy is right. Taxes are the ultimate evil.
These five points are the backbone of my thinking about the current market. They were arrived at by the recognition that I am in a business, not a religion. My business must perform well enough to be able to attract new money, keep a talented staff and make my existing investors happy. That way, I succeed; I am driven by success at work. (I am driven by other things at home, but this is not some lifestyle.com that you are reading.)

Over the next week I am going to flesh out these tenets, hopefully one day at a time, market permitting, because they are the keys to understanding this market.

Even as I write this I feel defensive about admitting these canons. It would be so much better to pretend that we really are in a business of evaluating businesses both short- and long-term.

But I know that is not true. I know it isn`t because for 20 years I would hear from individuals and institutions that the two greatest practitioners of evaluating businesses in the stock-picking game were Warren Buffett and Julian Robertson.

I am a realist about my skills. Those guys are the Michael Jordan and Ted Williams of the business. They are Hall-of-Famers. Even if you are a good .300 hitter you are in awe of Ted Williams. Everybody who plays pro basketball today is not as good as Michael Jordan. (Don`t sweat the program. Does it bother you that nobody has ever written as well as Shakespeare? That nobody has ever composed as well as Mozart and Beethoven, and the purists won`t allow Beethoven in the same sentence?)

But somewhere along the line Robertson got blown out of the shop. And Buffett`s methods have generated sub-par results for just long enough that, if he were doing what I am doing, he would have to close. Yes, close.

When we look back at this era, we are going to be sorely tested to understand why that is, and why someone like me, who cares passionately about picking stocks, got caught up in the need to be successful rather than pure.

It`s funny, for so long I was in a business that seemed to defy commercialism. In journalism we long ago accepted that the craft was, in the end, simple commerce. If you wrote well, wrote beautifully, about what people didn`t want to read, it didn`t sell and you couldn`t make a living from it.

It`s only right now that commercialism has overtaken the stock-picking business. If you pick stocks beautifully, but the people won`t buy them, you can`t make a living of it.

Given the crazy market, understand if I don`t get to these five tenets right in a row. But I have to hammer them home so you understand why some things work and why others don`t.

And so you can understand why I am considered to be excommunicated from the professional stock-picking flock for these commercial beliefs.

[investor_007]

Volatility Is the Byproduct When Market Makers Are on the Sidelines
By Aaron L. Task
Senior Writer
4/5/00 9:00 PM ET




Market-Maker Myopia
SAN FRANCISCO -- In the wake of Tuesday`s Steve Martin-esque market (wild and crazy), market players predicted the Nasdaq Composite had established the kind of bottom most desk jockeys can only long for. (Firm, that is).

But nobody forecast the volatility would end. Fittingly, the Nasdaq rose from its initial low of 4009.09 Wednesday to as high as 4286.88 before swan-diving in the final hour of trading. The index closed up a modest 20.45 to 4169.34.

Which brings me to Scott Bleier, chief investment strategist at Prime Charter (and a longtime column favorite), who was talking Tuesday afternoon about the role (or lack thereof) of market makers in the increasingly volatile stock market.

While others searched for catalysts to bloody selling early Tuesday , Bleier laid the blame on the very rules designed to protect individual investors.

"It`s not the economy, stupid," or the Microsoft (MSFT:Nasdaq - news - boards) ruling, the Fed or Abby Cohen, he said. "It`s not even about correcting excessive speculation. It`s about pure supply/demand and momentum. That`s what this market has become, due to best bid/offer" regulations.

Specifically, he referred to the order-handling rules established by the Securities and Exchange Commission in 1997. The rules forced broker/dealers to post limit orders with electronic communications networks (ECNs) or other "third market" participants. (Limit orders specify that stock must be bought or sold at a set price, vs. market orders, which call for the best available price. If you didn`t already know the difference, please learn it before you trade again.)

The rules resulted in a narrowing of spreads for over-the-counter stocks. In January 1997, when the order-handling rules went into effect, the average spread for a Nasdaq stock was 1.72%, according to the exchange. By February 2000, the average had narrowed to 0.31%.

That, of course, has benefited individual investors. But the shrinking profits had the (presumably) unintended effect of forcing some traditional market-making firms such as Lehman Brothers and Merrill Lynch to cut back their activities or to seek mergers to ensure survival. (Last month, TSC reported on Merrill`s plans to redouble its efforts in the area.)

At the end of February, 44% of all Nasdaq trades were handled by so-called wholesale firms such as Knight/Trimark Group (NITE:Nasdaq - news - boards), Herzog Heine Geduld and Charles Schwab`s (SCH:NYSE - news - boards) Capital Markets L.P. (formerly Mayer & Schweitzer) vs. 28% at the beginning of 1999, according to Greg Smith, a senior research analyst at Chase H&Q in San Francisco.

The purpose of this column is not to lament the demise of the "noble" market maker. The industry has what can generously be called a "spotty" track record of serving the investing public. In fact, the order-handling rules were enacted largely in reaction to the collusion of so-called SOES (small-order-execution-system) bandits in the mid-1990s. And there are plenty of conspiracy theorists who (mon Dieu!) still believe transgressions occur.

Market makers (they`re called "specialists" on the New York Stock Exchange) maintain a balance between buyers and sellers and, if necessary, will use their own capital to buy or sell stocks to ensure that balance. Or, at least, that`s been their traditional role.

Bleier and others note the narrowing spreads for over-the-counter stocks resulted in an unwillingness of market makers to commit capital.

"They don`t get paid to commit capital so nobody is willing to," he said. Therefore, "you get these blowoffs to the upside and crashes to the downside." In other words, why the Nasdaq could trade in a 700-point range in a day while individual stocks swung 50 (or more) points in either direction in a heartbeat.

Admittedly, certain market watchers have warned for some time that the market-making community would not be willing or able to step in and stem a big decline.

So ingrained is that belief that on days like Tuesday, when a stock such as Exodus Communications (EXDS:Nasdaq - news - boards) trades as low as 92 and as high as 140, institutional clients "have figured out no one is going to commit a lot of capital," said Timothy Heekin, director of equity trading at Thomas Weisel Partners in San Francisco. In fact, "customers in general aren`t asking for it."

The trader acknowledged the order-handling rules "exacerbated" the situation, but he deemed volatility the biggest cause of market makers` unwillingness to commit capital, rather than an effect thereof.

You can argue endlessly which came first -- volatility or a lessening of capital commitment (or why the market makers crossed the road, for that matter) -- but the bigger question is how market participants are dealing with the reality of the altered landscape.

The head trader at one San Francisco firm told me certain institutional clients have asked to be charged for his firm`s market-making services on a commission basis rather than on spreads, which is how NYSE specialists are compensated. This creates a "more effective market," he said, because the market maker is then working solely on the clients` behalf, rather than worrying about squeezing out a few "teenies" for themselves.

"I think the NASD is trying subtly to move the market in that direction," the trader said, admitting it is a bone of contention for wholesalers who cater more to the retail and online trading crowd and prefer getting paid on a spread basis.

NASD officials were unavailable to talk about this practice, but I`m certain the issue of how market makers get paid is central to the debate over creating a centralized market.

Meanwhile, Tim McCormick, an academic liaison to the NASD, denied the idea there is less capital being committed for OTC stocks, arguing that ECNs and others have replaced whatever market-making capacity was lost in the wake of the order-handling rules. The fact spreads have narrowed while volatility is on the rise is proof there`s ample liquidity, he said.

Furthermore, "market makers aren`t there to make sure the price doesn`t go down to X," McCormick continued. "They try to provide liquidity when they can. When there is a barrage like [Tuesday], they are not going to be in there holding up prices. They don`t have the capital to buy the whole market."

I wonder if that explanation is going to satisfy the irate reader who emailed Tuesday night, wondering "where the hell are these Nasdaq market makers that are supposedly there to assure an orderly market, the `buyers of last resort`?"

Given the investing public has clamored for cheaper, faster execution, those seeking salvation from the very market forces hampered by those requests should realize sometimes you do indeed reap what you sow. That`s something to keep in mind as the markets lurch toward decimalization, which is expected to narrow spreads further still.

[investor_007]

Manifesto for a New Market: Part 2
By James J. Cramer

4/7/00 6:42 AM ET




Editor`s note: This article is the second in a week-long series titled, "Manifesto for a New Market," which examines how the business of stock-picking has changed, what works now and why. The first piece in the series was published on Thursday.

When the book on this era gets printed, we will see a whole chapter about how the brokerage houses figured out a way to front-load the market for pizazz. But we will also read about how the backend produced an edifice built on shifting sand, not granite.

You know all of those delicious pops we have seen in so many initial public offerings? Those pops are artificial. They are created by stimulating demand well beyond short-term supply. That supply is kept as tight as possible to get people jazzed about a stock.

In an era where the actual going-public event is the ultimate in publicity, the desire to have a giant pop does produce some economic benefit to the company floating the shares.

A big opening makes those who got stock feel great. It makes those who got teased with some stock buy more to round out their positions. But it creates a false sense of supply and demand because the "float," the stock that is issued, represents no more than the tip of the iceberg. Usually 5 to 10% of the total stock gets issued. The rest gets held back in order to be sure of the success of the deal.

Just because it is held back, however, doesn`t mean it can`t surface. It is meant to surface at an opportune moment, long after a company has been seasoned and is trading substantially higher from its offering price.

Ideally, in this era, the initial public offering serves as no more than a loss leader. The rest of the stock is kept back, to be registered, usually six months after the company comes public.

There is only one problem. Many stocks can`t absorb that supply. Let`s take the case of National Gift Wrap and Toy.com, a mythical dot-com that sells toys and gift wrap online. The company comes public with a huge pop and lots of hoopla -- but not much float at all -- in the spring. Right before Christmas, when everybody is excited about its prospects, the real deal, the massive supply from all of the insiders, gets unlocked.

Most people who were in the stock didn`t know that it was artificially high, kept that way because only the tip of the iceberg was showing. Like the Titantic, the shareholder base takes a lethal hit when it brushes up against that giant floating iceberg. It collapses under its own weight when the artificial tightness disappears.

We are seeing these icebergs now come every day as one stock after another comes off its lockup and the float gets freed to trade. As many of these selling shareholders have a basis of pennies while the stocks sell for hundreds of dollars, they are insensitive to where they sell it. They are a new, post-IPO shareholder`s worst nightmare.


This whole backend loading of supply is a new thing, something that has changed investing and made us all into traders, as almost no stock can withstand this onslaught of sellers, causing the holders tremendous short-term pain. So, a money manager`s methodology in this new era has become something of enforced game of chicken. You have to try to get as much stock as possible on the initial public offering but as little as possible when you get to the lockup expiration. In fact, because of the sellers` dynamics you should actually be short the stock ahead of the lockup.

This process of creating a tight supply is total nirvana short-term and pure hell later. It is something that the older managers refuse to play, but it is the most lucrative portion of a hot market. It is a key tenet in any new money manager`s manifesto for the stock market in the year 2000.

[investor_007]

Fish or Cut Bait: Microsoft is not the market
By Peter D. Henig
Redherring.com, April 11, 2000
Forgive me for saying so, but this market is jiggy with stupidity.

After watching the Nasdaq fall 14 percent in two days this week, in line and in sympathy with Microsoft (Nasdaq: MSFT)`s 15 percent collapse resulting from Judge Thomas Penfield Jackson`s antitrust ruling against it, I must ask: did investors suddenly decide the technology revolution was over? That the global efficiencies created by high-bandwidth communications and the Internet infrastructure disappeared overnight?

Even if the tech market is now on the rebound, it is treading lightly, fearful of another slap at it by Fed chairman Alan Greenspan or Goldman Sachs (NYSE: GS)`s Abby Joseph Cohen. Or, apparently, a further spanking from the Justice Department.

Such insecurity seems ridiculous. Even sillier are the pundits and analysts, suggesting this is the beginning of the end for the market`s new economy stocks.

In my opinion, it`s only the beginning of the beginning -- a valuation reevaluation event, if you will. The market will pause, as it has often done, to reassess who the real winners are. It`ll pick companies like Oracle (Nasdaq: ORCL), EMC (NYSE: EMC), JDS Uniphase (Nasdaq: JDSU), Cisco (Nasdaq: CSCO), Broadcom (Nasdaq: BRCM), and America Online/Time Warner (NYSE: AOL), which represent high-quality, high-growth new economy stocks.

THE LOGIC DISEASE
Of course, there are those who note that it`s unreasonable to suggest the market shouldn`t tank because of trouble at one company, in this case Microsoft.

"You`re making an assumption that logic prevails in the market. That has never actually been proven true," says Pip Coburn, chief market strategist for Warburg Dillon Read`s global technology group.

Mr. Coburn and others see the market as susceptible to disease, possessing not enough white blood cells to defend itself from signal events. But in this case, it`s clear that investors still take news about the health or progress of the personal computer sector as one that implies strength or weakness for the technology sector as a whole. This benchmark is shifting as the Internet and other technologies subsume the role of the PC.

CORRECTED PERCEPTIONS
"The PC is dropping every day in importance in technology," says Mr. Coburn. "There`s a whole world outside of the PC, and investors need to start paying attention to it."

The first-quarter earnings season will bear this out. Although communications equipment stocks got slaughtered this week, dropping 22 percent, Internet stocks suffered a 29-percent decline. Mr. Coburn expects that earnings from the equipment makers, semiconductor companies, and communications services firms are going to be "stellar."

The earnings season works in favor of ending the current correction, as does timing. Mr. Coburn notes that in the past ten years, the typical correction in the Nasdaq lasts six weeks. We`re in week four of this latest one.

As for tech stock valuations themselves, back-to-back 400-point losses on the Nasdaq should wipe out those investors who were overly margined into admittedly fragile technology stocks, although further softness and volatility wouldn`t be surprising. The selloff, however, was not the end of the ride for the best technology stocks.

"Just like we saw in 1987, this slide was a valuation event, which ultimately leads to a separation event," says Charles Crane, portfolio manager with Spears, Benzak, Salomon and Farrell. "Investors will learn the difference between companies who are just selling stock and those that are selling real product."