Mutual fund investors are learning an important rule of 21st century economics. Yes, the world is changing, but stock prices can still go down.
You thought that was obvious, didn’t you? And it is, at least in theory. But many investors may have needed to see and feel it happen, as they are doing right now, because they’re not sure what rules apply anymore.
They hear all the time about a “New Economy” superseding the old. They’ve seen with their own eyes that stocks in this economy can keep rising for years after the market was deemed overpriced by conventional measures such as price-to-book-value ratios and dividend yields.
When the experts tell them that the fundamental principles of investing never change, they can rightfully answer, “Well, something sure is different.” They’ve watched old pros in money management Julian Robertson, Robert Sanborn and others walk the plank one after another, still proclaiming old principles of value that used to work so well.
One thing that is surely new is the dominant role played in the economy by information, which does not behave like soybeans or cold rolled steel. As Peter Drucker, the eminent thinker on business matters, said in Wired magazine in 1998, “the scarcity axiom doesn’t apply to information.”
When one person sells a telephone to another, Drucker pointed out, a simple exchange takes place. Money for goods. Afterward the seller no longer has the phone. But when A sells information to B, A retains the information even as B gains it. And A and B both now know that they each now know it.
We don’t know much yet about what might cause an information economy to misfire, and what the consequences might be. Can an oversupply of information get so severe that the market for it collapses, in the manner of a glut deflating the price of a physical commodity?
“There’s no shortage of information,” says Duncan Richardson, manager of the $325 million Eaton Vance Information Age Fund in Boston. “What there is a shortage of, perhaps, is knowledge.”
What’s an investor to do until we understand these things better? For starters, realize that you can’t get far simply trying to distinguish between the Old Economy and the New Economy.
That’s “a phony debate,” says Bob Turner, chief investment officer of Turner Investment Partners in Pennsylvania, which manages $8 billion in mutual funds and other accounts. The whole economy benefits, he says, from innovations like the Internet.
The crucial variance in impact occurs from one company to the next. Says Edward Yardeni, chief economist at Deutsche Bank Securities Inc. in New York, “The new paradigm driving the New Economy is a very old paradigm called perfect competition.” In other words, the New Economy in some important respects is just the Old Economy, working much better with much better tools. These tools greatly reduce friction, which results from incomplete information, say, or a geographical advantage, or the inconveniences of comparison-shopping.
That alone can inspire a lot of enthusiasm about the outlook for the world economy and for diversified equity investments like stock mutual funds. Uncertainty need not scare you out of the game. But while the new tools grease the wheels of the economy, they do not turn the markets into a free-money machine.
The value of a stock still rests on the underlying company’s present and prospective earning power. “Many, many companies owe their profits to friction,” consultant Gary Hamel said in a recent speech to the annual convention of the largest mutual fund trade group, the Investment Company Institute. “This is the end of friction as a source of profits.”
On a day like today, there’s one thing we clearly understand. While better economic tools may make for great opportunities, the stock market is still a two-way street.
Chet Currier is a columnist for Bloomberg News.
