More Un-Bubblish Behavior From the Market

This is a strange time in the stock market. On the one hand, prevailing wisdom among the chattering classes has it that current stock prices, especially on the Nasdaq, represent a bubble, and that the best we can hope for is for that bubble to lose slow air slowly, rather than in one giant burst. I started collecting examples of journalists saying things like “this overvalued market” and “Does anyone remember Japan in the 1980s?,” but I stopped because, well, I got bored. At the same time, though, no one seems to be actually selling their stock, perhaps because everyone’s succumbed to the siren song of long-term investing or perhaps because everyone always thinks they’ll be the ones who can get out just before the crash.

Or it may be that people are staying invested because for a supposed bubble in which prices are driven ever higher by indiscriminate investors, this market is actually quite discriminating, and its standards for corporate performance remain quite high. In an earlier column, I wrote about the segmentation of Internet stocks into winners and losers, and in recent weeks we’ve seen a mediocre Christmas further segment the Net sector by taking a real toll on Internet retailers. When Lucent recently announced that its quarterly numbers would fall well short of expectations, the stock dropped 40 percent. And today, Qualcomm saw its stock price drop 10 percent in a few minutes of after-hours trading despite the fact that the company announced that it had grown profits by 213 percent in the latest quarter.

Now, one way of looking at these sharp turns in market sentiment is to dismiss them by citing them as evidence of that much-dreaded “volatility.” But a more accurate way of looking at them is to see that investors are thinking hard about what news means for a company’s future earning prospects and are not interested in rewarding companies that fail to live up to expectations. (For further evidence of this, look at the market’s reaction to all the recent merger announcements.) It’s also the case that those expectations are very high, as the case of Qualcomm suggests.

Of course, the market’s expectations should be very high, what with the prices investors are paying. Qualcomm’s profits grew by 213 percent, but its stock is up more than 1,400 percent in the past year, so it may have a ways to go (down, that is) before it’s fairly valued. And Lucent’s quarterly numbers were more worthy of a slow-growing consumer-products company than of a high-priced tech giant, so the market’s reaction was hardly surprising. But what’s interesting is that it isn’t just stocks trading at stratospheric levels that are punished, nor is it just stocks that fall well short of expectations.

Take, for instance, SBC Communications, the largest Baby Bell, which announced earnings today right in line with analysts’ estimates. SBC’s profit and revenue growth weren’t staggering, but they weren’t disappointing, either. The company showed strong growth in its wireless business, which remains one of the hottest sectors around, and it issued a bullish forecast for the coming year. But Project Pronto, SBC’s $6 billion effort to roll out DSL Internet access to its local customers, fell well short of expectations. Since high-speed Internet access will soon be a crucial, perhaps the crucial, business for local phone companies to dominate, this was not good news. On a day when the market rebounded sharply in the afternoon, SBC finished the day down 10 percent. And this was not after a big run-up. On the contrary, the stock had already been down 28 percent over the last 12 months.

The market’s judgment was, I think, the right one. (Actually, SBC’s stock deserves to drop just on the basis of naming the DSL initiative “Project Pronto,” but that’s neither here nor there.) But the important point is that the judgment was made. In a pure speculative market, like the South Sea Bubble, it was enough to exist to coin money. And even in the months leading up to the Crash of 1929, or during the rapid rise of the Nikkei in the 1980s, corporate performance seemed to matter less and less. Say what you will about this market. There are no byes for the teams that are playing in it.