by Maggie Mahar
That “final slug” of liquidity that the Fed had provided in 1999 also helped keep the IPO market humming. Despite falling equity markets, 440 companies came public in 2000, almost all of them in the first nine months of the year, raising $100 billion—and breaking 1999’s record of $68 billion, according to IPO.com, a web site that tracked IPOs.25
Meanwhile, Frank Quattrone, Mary Meeker’s original mentor, had become the most visible investment banker in America. From his post in Silicon Valley, Quattrone had become the dealmaker sine qua non. There are hints that Quattrone, unlike Meeker, realized that the bear was on the premises: on December 4, 2000, he sent e-mails to staff, instructing them to clean out files related to initial public offerings.26
BEAR MARKET? THE 20 PERCENT RULE
But, unless they were insiders, most investors would not realize that the tide had turned until sometime in 2001. By and large, the media shared their faith. In 2000 the press rarely used the phrase “bear market” except in the past tense.
To its credit, as 2001 dawned, The Wall Street Journal seriously considered the possibility: “The new year begins with investors wondering if Nasdaq’s bloodletting is the vanguard of a broad-based bear market,” the paper observed, noting that the answer “depends mostly on whether the economy’s downshift in recent months is a pause in the longest expansion in a century or the first stage of a recession.” No surprise, Wall Street’s paper of record was able to report that “much of Wall Street opts for the former view.” The basis for Wall Street’s faith, once again, was the central banker Boston money manager Jeremy Grantham liked to call “Archangel Alan.” “Economists expect [the Fed] to lower rates soon, and propel stocks and the economy forward,” the Journal reported.27
In reality, a bear market already had begun, not because the economy was heading into a recession (though it was), but because stocks were wildly overpriced. As Ralph Wanger had warned, the proximate cause of the first avalanche can be anything, and, in the end, the trigger is unimportant. The snow had been building up for a long, long time. Now much of that paper wealth was melting away.
But even though the Dow had declined 16 percent, peak to trough, over the course of 2000, that 16 percent loss “failed to meet the 20% bear market rule,” The Wall Street Journal explained, echoing the received wisdom that a bear market has begun only when share prices have fallen 20 percent. In other words, if the market is down 21 percent in the morning, a bear market has begun—gain a couple of points in the afternoon, and you are back in a bull market. No wonder investors were confused. It was a statistic that nicely illustrated the difference between information and knowledge.
To back up their assertion that this was not, after all, the beginning of a lasting downturn, financial pundits compared the 2000 crash to the disastrous plunge of 1973–74. In ’74, the bear devoured everything in sight. This time, by contrast, high-priced stocks such as Cisco Systems were still standing. At the end of 2000, Cisco ranked as the fourth most valuable company in the country, right behind General Electric, Exxon Mobil, and Pfizer. Wal-Mart ranked fifth, Microsoft sixth, followed by Citigroup, American International Group, Merck, and Intel. “Stocks like Cisco and EMC, both now at about 100 times trailing earnings, can remain high-priced for years,” Lehman Brothers’ Jeffrey Applegate asserted.
Apparently it did not occur to most market strategists to compare the losses of 2000 to the mauling of 1970—in what turned out to be only the first leg down of the bear market of 1966–82. Following that crash, the Nifty Fifty of the seventies also stood tall. Those blue chips would not be decimated for another three years.
But at the beginning of 2001, the majority of Wall Street’s best and brightest seemed unencumbered by any too-detailed knowledge of market history. “As a group, market strategists are the most bullish they have been in the 16 years Merrill Lynch has surveyed them,” the Journal reported.
Only Merrill’s own head of quantitative research, Richard Bernstein, remained unenthusiastic, finding his colleagues’ high spirits “both ironic, given that cash and bonds both trounced stocks last year, and sobering, since markets usually bottom at the point of maximum pessimism, not optimism.” Bob Farrell, Merrill’s veteran market timer, agreed: “Knowing the market’s tendency to return to the mean, value investors will be the ones who make the most money in the next few years,” Farrell predicted. “Technology stocks won’t make a long-term recovery until their current owners give up on them.”
But Merrill’s bears were in a distinct minority. At the beginning of 2001, with the Dow at 10,786, most saw a buying opportunity. Indeed, Ed Kerschner, Gail Dudack’s replacement at UBS Warburg, fairly salivated at the prospects for the year ahead, calling the moment “one of the five most-attractive opportunities to own stocks in 20 years.” In 2001, he predicted, the S&P would jump 30 percent.
PUMPING WATER INTO THE BOAT
As for the Fed chairman, by the end of 2000, Greenspan had abandoned his quixotic fight against inflation. After all, he had, in fact, been tilting at windmills: the problem was not that the economy was too hot—it was too cold. When the Fed met on December 19, economic growth had slipped to 2 percent—down from 5 percent early in the year. The Fed hinted that it was likely to ease once again. And on January 3, 2001, even before the FOMC’s next scheduled meeting, it announced that it was slashing the funds rate by a full half point, bringing it down to 6 percent. For Greenspan, to slice rates by so much in one fell swoop was unusual. The timing seemed, to many, political. The day that Greenspan called an emergency meeting to cut rates “just happened to be the day” that President Bush “held a confab with business leaders in Austin, Texas,” Justin Martin noted in his biography of the Fed chairman. “Some big-name CEOs were present: GE’s Jack Welch, Boeing’s Phil Condit and Craig Barrett of Intel. These were the heads of businesses that were starting to feel pain from a slowing economy…. When the rate-cut announcement came down, Jack Welch raised a glass of water to toast Greenspan.”28
Martin Mayer, a leading expert on the Fed, agreed about the timing of the cut. “The one thing certain to come from that meeting was a call for lower interest rates. To wait until after the call was uttered would have made the Fed seem subservient.”29 By anticipating the command, the Fed was, instead, a good servant.
When the Fed trimmed rates in January of 2001, the market rallied—briefly. Before the month ended, the Fed took another whack at the Fed funds rate, bringing it down to 5.5 percent, the first time in Greenspan’s tenure that rates had dropped a full point in one month.
At about the same time, the Fed chairman did a surprising about-face on the question of President Bush’s proposed tax cut. Long known as a fiscal hawk who put cutting the deficit well ahead of lowering taxes, Greenspan stunned Democrats by telling the Senate Budget Committee that “the sequence of upward revisions to the budget surplus projections for several years now has reshaped the choices and opportunities for us,” giving Congress the green light to back the tax cuts.30 Of course, surplus “projections” were just that—guesses about the future—and surpluses are meant to serve as a buffer against uncertainty. Over the next two years, the surplus, like so much of the phantom wealth of the nineties, would simply vanish.
Meanwhile, from 2001 to 2002, a string of rate cuts would have only a transient effect on the stock market. Because what ailed the market was not that rates were too high, but that earnings were too low. Cutting interest rates helps businesses flourish only if they have a reason to borrow, build, and expand. With profits anemic, businesses had no motive to borrow—thus rate cuts would not motivate them to spend. Easy money would fuel a boom in the housing industry, making it easier for individuals to refinance their mortgages and buy new homes, but it would not boost capital spending by business. And in the end, that is what would matter.31
By February of 2001, when Greenspan delivered his semiannual report before Congress, he was forced to acknowledge a “temporary glut” in high-tech manufacturing. Too much money meant too
much supply—too many cell phones, too many chips, too many PCs. But, Jim Grant observed, Greenspan “missed the point that the glut was the product of the bubble—and of the systematic undervaluing of capital and credit—and therefore risk.” Thanks to the euphoric effects of a nonstop bull market, anyone could raise money. Capital was cheap because risk seemed, to so many investors, nonexistent.
Failing to recognize the root of the problem, in 2001, Greenspan continued to be optimistic about corporate profitability, noting that “corporate managers ‘rightly or wrongly’ appear to remain remarkably sanguine about the potential for [technological] innovations continuing to enhance productivity and profits. At least,” he went on, “this is what is to be gleaned from the projections of equity analysts who, one must presume, obtain most of their insights from corporate managers.”32
DENOUEMENT AND DEBT
Over the next two years, the Federal Reserve would continue to cut rates systematically—the Fed’s critics would say frantically—all the way down to 1 percent in June of 2003. After adjusting for inflation, “real” interest rates were now below zero. But while a central banker can open the spigot, he cannot control where the money will go. The Fed could not force businesses to spend.
“For those who believe that markets solve their own problems—and they are clearly dominant in the present Bush administration,” Martin Mayer had written in the summer of 2001, “the disconnect between the Fed and the desired effects of its actions is of little concern. All they wanted from Alan Greenspan was his endorsement of a large tax cut, and he gave it to them.”33
By 2003, many in the administration would be less confident that the stock market could solve its own problems. But it was not at all clear that Alan Greenspan possessed the needed magic either.
In May of 2003, Pimco chairman Bill Gross summed up the problem: “Sure, policy makers [can] keep on applying the kindling…to the fire” as they try reignite the economy—“low interest rates, increasing fiscal deficits, and perhaps even a Bernanke blowtorch if need be,” added Gross, referring to Federal Reserve Governor Ben S. Bernanke’s suggestion that the Fed stood ready to cut the funds rate to zero. (If necessary, Bernanke declared the Fed would use “nontraditional measures” to support the economy.)34 “But that’s not a self-sustaining fire,” Gross observed. “If anything it leads to more bubbles and new instabilities. For a fire to keep on burning late into the night you need the logs to catch, and the world’s economic firewood has long since been soaked by oversupply and feeble demand.”
Meanwhile corporate, consumer, and government debt mounted. By 2003, the heap had grown to $32 trillion—up from about $4 trillion at the beginning of 1980, according to the Federal Reserve. In the private sector, corporate America was staggering under that burden of debt—another reason, Gross noted, why the government’s efforts to stimulate capital spending were meeting with little success: “In order to get out from under the 16-ton sledgehammer of debt, companies use cash flow to build reserves or retire bonds—they don’t invest.”35
There was still some hope that the debt would prove manageable. “There’s no question that we have a debt bomb, but I’m not sure how long the fuse will turn out to be,” Morgan Stanley’s Steve Roach observed in January of 2003. “It won’t detonate if the economy remains strong enough to continue to generate enough real consumer-income growth and corporate cash flow to support the debt. Otherwise, we’ll experience the darkest scenario of debt deflation, as a result of the worst set of policy mistakes committed by the Fed since the Great Depression.”36
For the near future, one thing was all but certain: the nation would be able to pay off its debt only if interest rates remained low. Fed Chairman Alan Greenspan had no choice but to keep on whittling, even while the New Economy burned.
A FINAL ACCOUNTING
—20—
WINNERS, LOSERS, AND SCAPEGOATS (2000–03)
By February of 2002, 100 million individual investors had lost $5 trillion, or 30 percent of the wealth they had accumulated in the stock market—just since the spring of 2000. There was nowhere to hide. At year-end, $10,000 invested in an S&P 500 index fund three years earlier was worth less than $6,300; $10,000 stashed in a large-cap growth fund had shriveled to $4,900. Just 43 of 5,500 diversified U.S. stock funds wound up in the black.1
The bear had taken no prisoners. After three consecutive years of losses, the Dow now stood at just over 8341—down from a bull market peak of 11,722. Meanwhile, the Nasdaq had plunged from roughly 5048 to 1335.
Individual investors had been mauled. Who were they? Sixty percent lived in the suburbs; most had college, graduate, or professional degrees; a disproportionate number were baby boomers between the ages of 35 and 49 living on the East or West Coast (southerners were less likely to invest). Active traders tended to be Republicans. Nearly half earned more than $75,000 a year.
But many were less well educated, earned lower incomes, and would have less time to make up for their losses before facing retirement. A majority of Americans earning $30,000 to $50,000 were now in the market, as were 40 percent of all senior citizens.2
Jim Tucci was typical of the older investor. In just two years, the 60-year-old Boston sales manager had seen half of his $600,000 nest egg disappear. Tucci had lost part of his savings gambling on Internet stocks—but those were not his only losses. In 2001, he sought safety in reputable names such as IBM, Merrill Lynch, General Motors, and Delta Airlines. By early 2002, half of that money was gone.3
Those who could afford it least lost the most. In 2003, a Vanguard survey revealed that 401(k) investors with balances of $50,000 to $100,000 saw their savings shrink by 5.3 percent a year over the three years ending December 31, 2002. Over the same span, investors with more than $250,000 lost less than 1 percent a year.
Part of the difference could be explained by age. Older investors who had been saving longer were more likely to have accumulated more than $250,000. By and large, they also proved less susceptible to the “cult of equities,” and so had done a better job of diversifying, entrusting a larger share of their savings to bonds. Nevertheless, the average investor in his late 50s saw his 401(k) grow by only 1.2 percent a year over the five years ending in December 2002—far less than the 4.9 percent earned by investors with accounts of $250,000 or more.4
Age alone, then, did not explain the enormous gap. Once again, much would hinge on how soon any investor joined the party, and how much he invested during the final blow-off. Here wealthier investors enjoyed a distinct edge. As the Securities Industry Association’s surveys had demonstrated, they were more likely to have carved out a position in the bull market in the eighties or early nineties. Middle-income investors, by contrast, came to the party later; many did not buy their first stock or stock fund until sometime after 1995.5 By then, 401(k)s had multiplied. More middle-income investors were running their own retirement funds, and they had become more confident of their investing prowess. Many who bought their first stock in 1996 would not really begin shoveling money into the market until 1999 or 2000, buying on dips all the way down.
These investors were not as likely to have financial advisors. They turned to the media for their investment advice, and so were drawn, like moths to the flame, to the white-hot stocks that made headlines.
SHIRLEY SAUERWEIN
Some were luckier than others. In the late nineties, Shirley Sauerwein’s story took an unexpected twist. Sauerwein was the social worker from Redondo Beach, California, who made her first foray into the market in 1991, buying a company that she heard about while listening to the news on her car radio. The good new$bad news was that the company would turn out to be MCI WorldCom—a highflier that would go under, costing shareholders some $180 billion.6
By 1999 the $1,200 she had bet on a fledging telecom company was worth $15,000—part of a mid-six-figure portfolio that included Red Hat, Yahoo!, General Electric, and America Online. At that point, Sauerwein had cut back her social work to weekends and was spending
weekdays trading full-time from home. She also managed her husband James’s retirement account.
That year, The Wall Street Journal had singled out Sauerwein as an example of the individual investor’s new power: “Along with Wall Street’s heavy hitters, Main Street investors like Ms. Sauerwein have emerged as a powerful financial force in the 1990s, simultaneously boosting their net worths beyond their wildest dreams and helping to propel the market to records.” To a skeptical reader, Sauerwein sounded like a lamb waiting to be fleeced.
“I’m not a smart cookie,” Sauerwein declared at the time. Yet she seemed to have avoided falling prey to the widespread belief that stocks always go up. “I never thought this would last,” she said in ’99. “I just thought, ‘I’ll get in and buy some tulips.’” She also made it clear that her sense of self-worth was not at stake: “If a stock goes up, it’s not because I’m a whiz.” Like many of the most successful professional traders, she realized that, at bottom, this was only a game. That would make it far easier to sell.
In fact, even when she was winning, Sauerwein took profits off the table. In the late nineties, she began trimming some of her holdings—including WorldCom. “I’d read something about management—and how they were spending their own money. It sounded extravagant,” she recalled. “How people run their own lives tells you something, and I thought to myself, ‘They’re not keeping an eye on business.’” She also sold Nokia: “I saw that people were giving cell phones away, and I thought, ‘There can’t be much profit in that…’” Finally, in 2000, Sauerwein made a brilliant move. That year, she cashed in all of the stocks in her husband’s 401(k), sweeping the money into a money market account: “At that point the account had gone down less than 5 percent, but I just had a strong feeling that there had to be a significant downturn,” she recalled.