MARGARET WARNER: The NASDAQ Composite Index was created less than 30 years ago for fledgling companies that were too small or too weak to be listed on the bigger, more prestigious exchanges. But today this index of about 5,000 companies, many of them in the computer, communications, biotech and Internet sectors, is the growth powerhouse of Wall Street.
The NASDAQ has jumped from 3,000 to more than 5,000 in just four months, accelerating a trend of dramatic growth through the 19 90s and far outperforming the Dow Jones Industrial Average, which has actually declined in recent months. Is this growth justified? We turn to Ash Rajan, Senior Vice President at Prudential Securities, and David Levy, Vice Chairman of the Jerome Levy Economics Institute at Bard College. Welcome gentlemen. David levy, 3,000 to 5,000 in four months.
Is this run up justified?
DAVID LEVY: In terms of any long-term valuation, no. I think it's a clear case of a speculative market that has gained enormous momentum and has put on a crescendo, has had a crescendo much like other speculative markets before it that have ended badly.
MARGARET WARNER: Now, when you say "speculative market," what do you mean?
DAVID LEVY: Well, I think, you know, there's always a healthy kind of speculation in the market and in the economy, when people are taking risks and hoping that they'll invest in something that will have productive returns. But when it gets to the point where people are investing simply because they think something will go up and they've stopped paying attention to the underlying value-- in this case, the earnings of companies, or in the case of real estate in the 1980's, the rents that could be earned-- it takes on an emotional, irrational character which can be very... go on for quite a while, but ultimately it's found out that the emperor has no clothes.
MARGARET WARNER: So, Ash Rajan, do you think that's what's happening here, emotional and irrational growth?
ASH RAJAN: Margaret, I would have to gracefully disagree with David. His point of view was very relevant when the Dow... when the NASDAQ was at 3000. It certainly was even more relevant when the NASDAQ was at 4000, and now with a new milestone. I do grant that there is a speculative froth underneath of all these movements, but there are some very tangible reasons why stocks in the NASDAQ react the way they do. If you look at the wireless, if you look at the semi-conductors, e-commerce, software, and biotechnology, these are very real technologies that are driving the way we do business and driving the way we live.
MARGARET WARNER: Well, David Levy, we keep reading that a lot of investors are actually moving their money out of the Dow Jones Industrial Average companies and into these NASDAQ companies, as Mr. Rajan just cited some of them. Some of the others are Microsoft, Cisco System, Intel. They seem to be betting that these are the new core stocks of the new millennium or the new century. I mean, are they wrong about that?
DAVID LEVY: Well, I think investors are very good at identifying trends and jumping on bandwagons, and that's what we see. They're getting off a sinking ship and onto one that they think is going to go sailing off. If I can address the issue of these new technologies, sure, they're new technologies, they have a lot of promise, they're going to grow a great deal. I don't disagree with that. But there's not a great revelation that's taken place in the last four months that should have pushed them up another two- thirds in value. The important thing is, you know, you could say many of the same things about technologies in 1929, about broadcasting, the spread of telephone, automobiles. It doesn't mean that there is no limit to what should be paid for a stock just because it has a lot of long-term potential, nor does it mean that there cannot be some rather serious financial consequences along the way that can derail that train before it reaches its ultimate destination of, in this case, technological development.
MARGARET WARNER: What about that point, Mr. Rajan?
ASH RAJAN: Well, I think the dynamics this time around are certainly different, and I'm not alluding to the "new paradigm" school, if you will, but this is reality. Let's take this very show, for instance. You're sitting, Margaret, in Washington, D.C., David's in New York and I'm in Boston, and we're making this happen thanks to fiber optic technology, thanks to routers and an ATM synthesizer, thanks to magnifiers and just about everything that makes this network equipment possible. That's just a microcosm of the society that we live in. You could have made cell phone calls this morning or sent e-mails and you would have evoked the same infrastructure and that's the infrastructure we're paying for via the stock prices of the companies that make them.
DAVID LEVY: Okay, wait a minute. We... A lot of this technology that we just referred to has been around with us for a few years, now, and in fact, if we want to talk about what we're paying for, we have to talk about what kind of contribution it's making to the economy, and when you see companies that, even if they have fantastic growth, will still have only a fraction of the sales five or ten years from now that some of our great blue chip companies have -- you know, you have to wonder, "well, wait a minute, if we look at the mechanics of the actual earnings and do the math, how on earth do we justify some of these prices?" I'm not saying there aren't some stocks that will be great successes and are worth it, but I think overall, when the NASDAQ has grown ten times faster than GDP, the overall stock market in the last ten years, if we look back to 1982, the beginning of the boom, the overall stock market has grown about 15 times when the economy has only less than tripled. This cannot keep going.
MARGARET WARNER: Mr. Rajan, are you saying earnings are irrelevant here? I mean, that used to be the old valuation of the stock?
ASH RAJAN: Not even close. I think earnings are very relevant. The old school of equity analysis is still very relevant. It's what you're willing to pay for these technologies is what's becoming sort of the contemporary and controversial thing. However, if you ask an old world company, if you will, like a GM or Ford, they will tell you, and they will tell you with passion, that they want to become a part of the new economy and the investing of the business-to-business E-commerce infrastructure to get to exactly doing that, to be more productive. It's not about increasing the sales or market share, it's just about savings-- huge cost savings-- that's coming with technology investment. And those enablers that make it happen do get rewarded with higher stock prices. That's all I'm alluding to.
MARGARET WARNER: Mr. Rajan, staying with you for a minute, who are the investors who... let's look at who they are, who are going into this. I read a piece in the "Wall Street Journal," the lead story today, and they told an anecdote about a broker, a conservative broker who always looked at earnings and so on, and clients coming in and saying "I want you to beat the S&P 500 or I'll find someone who can." Is that happening a lot?
ASH RAJAN: Margaret, yes, in fact it is. We see that happening in the retail individual front. We have empowered virtually just about every investor out there, especially the individual investor, about the potential part of the stock market. We have certainly spoiled them. But they will learn from their mistakes. The best education is not listening to experts like us, but making their own mistakes and learning, and that's what David has alluded to, this "froth and speculative action." That will have a way of settling. But there is no denying the power of the new technology and the cost and the price that we have to pay to have it.
MARGARET WARNER: Go ahead, David Levy.
DAVID LEVY: We've had... I mean, look, we had tremendous new technology which has, I think, had a bigger impact on the way business is done, so far. That may change. Just looking at personal computers coming in, and some of the changes in networking that that brought. We've had, I think, the revolution of the telephone, which made instantaneous communication possible for the first time earlier in this century, was far more profound in saving costs than the Internet is, or some of the other communications technologies.
MARGARET WARNER: David Levy, let me interrupt you on sec, just to comment, too, though on this "who are these investors?" What would you say is the difference? Is there a new mindset? Do we have, now, people investing in the old economy versus different kinds of people in the new economy?
DAVID LEVY: I think that what we have is, we've entered an era where people are not afraid of losing money, they're terrified of missing gains. We've had 18 years of the greatest bull market in U.S. history, with very few and relatively short interruptions. This has led to a perception that risk is very, very low. Yet, I refer to the Former Treasury Secretary, Robert Rubin, who's been speaking and writing recently about the extreme risk that's being ignored both globally and internationally by the financial community. We're living in a bit of a fantasy land here, ignoring the fact that, you know, we have to think about playing defense when market values become record. And even adjusted for interest rates, we've broken the 1987 record. We're more overvalued than ever before.
MARGARET WARNER: Ash Rajan, do you tell your clients this, that the bubble could burst?
ASH RAJAN: Margaret, no, I don't. I tell them to be disciplined, one -- to understand the risks that they are taking on. But I also tell them if they cannot handle the volatility, then they will have to really get out of the kitchen, because if they can't handle the heat, they're really better off in what their instinct leads them to invest. However, I also simultaneously tell them that there is at real meaning for all of these new technologies and the way they're taking place. And when I see the so-called "old economy" names use technology as the ticket to get to the new economy, that gives me much more credibility and it endorses this whole momentum that we're seeing. I happen to agree with David to the point that there is some sense of gravity to all of this at some point. Nothing goes up forever. However, we have to acknowledge that investments in very, very specific leadership areas of technology, telecommunications, semi-conductors, software, and even biotechnology, for that matter, are justified and are tangible.
MARGARET WARNER: All right. Ash Rajan, David Levy, we have to leave it there, but thank you both very much.