RealTime IT News

Rate Hike Fears Are Market's Biggest Variable

If you take a traditional summer slowdown and toss in talk of the Federal Reserve triggering interest rate hikes it spells a wipe out for Internet shares. None of the 50 stocks in ISDEX was left untouched in the ongoing correction that's knocked 14% off Internet stocks since May 13, 7% of that coming yesterday.

Beyond rate hikes and doldrums, the underlying problem is economic: too many IPOs chasing too few interested buyers.

This was exactly the backlash I predicted would come if too many Internet public offerings jammed the pipeline. It took some of the luster out of the "dot com" space as investors simply cannot keep up with 100 issues waiting for beach-head.

The backlash has come and gone before, with overcrowded dockets flush with IPO candidates. We need only time travel to July/August 1998 and April/May 1997 to see how the Internet stock market got diluted by new issue orgies.

Each time the market recovered. It pays to draw up those stats and see what effect was of the combo of summer slowdowns and IPO fever. First, note the anomaly year and period between December 31, 1996 and May 26, 1997 when ISDEX lost 17%.

Those were the days of genuine investor apathy and not a day trader in sight, there simply wasn't the interest in Internet stocks. The interest grew, however, in the latter half of 1997 as ISDEX ended the year just over where it began.

Said another way, the latter half of the year in what was a bearish year for Internet stocks in general, proved to have some legs to it. Check the table:

  31-Dec 24-May/26-May % change
1997 99.5 82.84 -17%
1998 99.87 137.94 38%
1999 286.73 510.55 78%
  24-May 31-Dec % change
1997 82.84 99.87 21%
1998 137.94 286.73 108%
full-year 1998 99.87 286.73 187%

It wasn't until 1998 as the Internet started moving outward off the early-adopter base that Wall Street began taking the sector seriously as an investment opportunity. With that, December 31, 1997 through May 26, 1998 ISDEX gained 38% at a time when the Dow and NASDAQ were nowhere close.

The latter half of 1998 from May to December saw ISDEX rise another 108%. 12/31/97 to 12/31/98 ISDEX tally came to 187% gain.

Now in 1999 and Internet stocks front and center (as stocks for the new information age) the ISDEX year to date through May 24 ran to 510.55, up 78%. It has been as high as 696.76, which means ISDEX is down 27% of its high so far this year. At the top, ISDEX was up 143%, so it's well off that mark now.

The variables driving down values are threefold, just so we're clear:

1) in summer months there's typically a slowdown due to technology buying cycles slowing down, accounting decisions being made for the next year.

2) too many Internet IPOs coming at once, diluting the market for new issues and causing some dilution for existing public companies in the same sector.

3) And this is perhaps the most variable element, interest rate concerns.

For in 1997 and 1998 these variables crept up from time to time but not in synch with each other to the degree they have done in May, 1999. Now the effect of the fear of a rate increase may actually have the desired effect on capital flow without the implementation of an actual rate increase.

How? the stock market's already factored the possibility into stocks and bonds, mortgages. I would posit that the full discount may not have been applied to rate pressure in stocks but that the net effect (and Net effect) has been input into the market.

Said another way, I think we're in a more hyper-sensitive market for Internet stocks than ever before but one which has digested some of the variables in prices already. That's how ISDEX is off 14% in two weeks.

I believe that the outlook for the next few weeks looks like rate fear may drive the market more than any other factor. That valuations for Internet companies may waver some more against that backdrop and a more earnings-conscious investor.

Moments like these also serve to separate investors from speculators quite quickly. Speculators panic while investors know their threshold for risk and reward (or they should now).

Is it now a buying opportunity? That depends on your risk and reward criteria. I believe Internet stocks as a group may experience more shakeout on value and that the better stocks may rise from the cluster.

"Better" to me is defined as market leaders, strong revenue growth, large user base, substantial working capital ($100m or more to weather any capital squeeze which interest rate hikes could spark), and management focused on building business.

If the summer meltdown continues it may be a chance to own some of these stocks at more reasonable levels. At the very least a valuation softening could lead to more mergers and acquisitions as these firms seek efficiencies and scale.

Third and fourth quarter will tell the tale if the past 3 years pattern for the second half of the year repeats itself. The wild card is rate increases.

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"Fresh and provocative" -CBS Marketwatch, who named Steve Harmon one of the top Internet stock analysts and only independent one honored

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