MARKET COMMENT
Why The Stock Market Is Falling - Part One

By Bruce Jackson (TMFGoogly)
June 19, 2002

With the FTSE 100 index well below the 5,000 level, and staring at its 3rd straight calendar year fall in a row, many private investors are wondering what has gone wrong.

There are four main reasons as to why the stock market is falling. Today brings the first instalment, with the rest of the reasons coming your way this Friday 21st June. To make sure you don't miss it, sign up to the Fool's free Lunchtime email, sent to your in-box each and every working day.

Reason 1 - We're Still Running Off The Excesses Of Yesteryear

Internet Companies

The Internet was supposed to change the world. To a large extent it has -- for example, the Motley Fool would probably never existed if it wasn't for the Internet -- but what it hasn't changed is the way the world does business. The Internet is simply an alternative distribution medium. Many of us realised that at the height of the dot com boom, yet many of us still believed that businesses using the Internet should be valued as if they would create significant additional profits in the years ahead. In reality, many Internet companies have closed and most still lose money.

Telecom Companies

Telecom companies went hunting for the Internet riches. They built large and expensive networks, spending millions today in the hope of making millions more in profits in the years ahead. Businesses and consumers were expected to use more and more bandwidth capacity as we downloaded music, movies and games, to name but a few of the predicated mass-market 'hobbies' we were expected to adopt. But, over-capacity and slow adoption rates soon saw telecom companies struggling. The result? Some telecom companies have filed for bankruptcy, many are struggling under mountains of debt, and most are losing money.

Free Money

Money was free. Venture capitalists (VCs) were throwing money at anything remotely looking like it was a TMT (Telecoms, Media, Technology) company. Once a company secured cash, the stock market and the VCs dictated it was spent as fast as possible. So spend it they did, on people, on computers, on networks, on office space, on launch parties, on table football machines, on booze and on marketing. Spend, spend, spend.

No Money

Then, all of a sudden, in mid 2000, the capital markets closed. Free money became no money as VCs and banks stopped lending to heavily indebted and/or loss making companies. Profits were the new game in town. If you couldn't get to profitability with the cash you currently had in the bank, you perished. Bust. Out of business. Kaput.

Slash Costs

Given these conditions, what do most companies do? They stop spending money. They slash costs, primarily by sacking staff. Brand marketing is suddenly seen as largely the expensive luxury it has always been. Staff are sacked, as are all those expensive over-paid and under productive consultants. As companies close, there's a glut of computer equipment on the market, and companies find the computer equipment they still own can last for 4 to 5 years.

Downward Spiral

The end result is that there's a nasty downward spiral effect throughout much of the corporate world. Company A stops buying stuff from company B, who in turn can't afford now to buy stuff off Company C, and so on. More staff are sacked and more computer equipment hits the already flooded second hand market.

Over-valued companies

At the stock market peak, many TMT companies were so ridiculously over-valued that some sort of fall from grace was inevitable. But, when you couple that natural re-rating with rapidly falling profits (or increasing losses, or yet more years before reaching profitability) you can easily see why some TMT companies are down more than 90% from their 2000 peak.

Bubble

There's no doubting that from 1998 to mid 2000, we were living in an unsustainable bubble. The massively over-hyped Y2K bug coupled with the alleged infinite scalability (and therefore profitability) of any Internet company saw unsustainable corporate spending in those years.

And That's Why The Market Is Falling...

When a bubble bursts, it takes a long time for economic normality to return. It could take as long as five years. It could take even longer. But, there's no doubting that today's stock market falls are still a direct effect of the excesses of yesteryear.

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