MARKET COMMENT
Y2K Strikes Again

By Bruce Jackson (TMFGoogly)
February 28, 2001

In stock market terms, the year 2000 will go down as an unusually eventful one. Way back on day one of the year, as Big Ben ticked past midnight and into the new millennium, we quickly realised the much vaunted Y2K effect was all a crock. Individuals and corporations around the world had been scared into spending heavily to update and make compliant all their IT hardware and software. To this layman, much of this spending was unnecessary, at that time.

But spend they did. A spending bubble was born as corporations accelerated their IT spending. Just about any old company operating in the hardware or software business was a beneficiary, not only in terms of increased sales, but a vastly increasing share price. Investors looked at the growth rates of 1998/99 and extrapolated those growth rates out 5 and 10 years, thereby justifying stratospheric stock market valuations.

The stock market got it all wrong, as it so often does during speculative bubbles. The pre-Y2K spending turned out to largely be one-off expenditure for most corporations. As the reality of this sank in, throughout 2000 many technology companies warned that profits would be lower than the Y2K-induced, turbocharged levels seen in 1999. The FTSE techMARK 100 Index peaked at over 5700 in March 2000. Today it stands about 60% below that mark, at around 2300.

Technology companies are the most obvious casualty of the Y2K effect and the subsequent bursting of the March 2000 stock market bubble. Media and telecommunication companies are also suffering. But there's a new wave of companies now starting to suffer from their very own Y2K effect -- fund managers and stock brokers.

Institutional and private investors alike piled into the stock market in the early part of 2000, many with gay abandon. The media regularly reported of permanently engaged phones at execution-only brokers. Some online brokers found their sites buckling under the strain of massive demand. More staff were needed to cope with the demand, and needed quickly. The stock market recognised another growth market, and shares in the broking and fund manager firms were bid higher and higher. The growth rates of early 2000 were again extrapolated over 5 years as investors justified paying premium multiples for these companies.

Bang! The bubble suddenly burst. No-one wants to trade shares any more. Many private investors are turned off the stock market for life, their only souvenir being 35 shares in Lastminute.com (LSE: LMC). Brokers and fund managers, having employed extra staff and spent heavily on IT equipment as the stock market soared, are suddenly finding themselves rather exposed as trading volumes and investment somewhat dry up.

Brewin Dolphin (LSE: BRW) warned of lower profits. Schroders (LSE: SDR) warned that profits from asset management and private equity in 2001 would be lower than in 2000. The Y2K effect strikes again.

But the silver lining surrounding this particular cloud may shine brighter than that of the beleaguered TMT sector. Valuations aren't nearly as stretched. If you believe in the long-term prospects of the stock market, the Speciality & Other Finance sector may prove to be an attractive hunting ground. The Y2K effect may take some time to filter through, and share prices may get worse before they get better, but fund management is a growth business, and you don't often get the chance to buy growth on the cheap.