Are there really two separate economies?
We've heard it a million times: The "New Economy" is growing and dominating the economy, while the "Old Economy" is stagnating and on its way to the figurative scrap heap.
But are there really two separate economies and two stock markets?
The United States has always been a fountainhead of technological innovation. The railroad dominated long-haul transportation from about 1850 until a new technology--the internal combustion engine and the automobile and truck--gained relative dominance by 1950. What we are really referring to when we say the New Economy is not the personal computer and microchip but the information economy enabled by the World Wide Web and the infrastructure over which it travels: the Internet.
To gain some perspective on the explosive growth of the Web and the Net, let me note that in 1993 there were, globally, some 130 Web sites. Today of course there are millions. It would be difficult to find a company that is considered to be a growth company and part of the New Economy that is not intimately connected to the Web and the Net, from Cisco to Broadvision, Amazon.com and AOL.
A prototypical Old Economy group of companies are the electric utilities, which use primarily coal and some uranium to generate power that is used by homes and businesses. The technology here has hardly changed for 100 years or more, except for a series of marginal improvements, particularly in the areas of pollution abatement. And yet when you think about the first thing you do every morning--hit the snooze button on your alarm clock--doing without electricity in a modern economy is unimaginable.
To verify that we still value the companies that generate and distribute electric power, we can look at this year's relative stock market performances of networking equipment giant Cisco and energy provider American Electric Power. On Jan. 1, 2000, Cisco was priced at about $54.75 per share, while American Electric Power's price was about $32. When the tech market peaked in March, Cisco topped out at approximately $79.50, while American Electric Power bottomed at $26. On Dec. 8, 2000, shares in Cisco closed at $52.38 38--almost exactly where it began the year--while American Electric Power closed at $45.19, up 42 percent since the start of the year, and up 75 percent since its low for the year.
This would indicate that there are, in fact, two economies, the Old and the New, although I would argue that has always been true. New technologies in our innovative society are constantly being born, and some of these grow up to be dominant drivers of the economy. However, if we consider that American Electric Power was priced at $51.50 in early October of 1998, while Cisco was priced at $10, it becomes clear that Cisco is a New Economy growth stock while American Electric Power is an Old Economy cyclical. (Note: interest-rate driven cyclicals like American Electric Power tend to move up in anticipation of interest rates topping out but before the economy slows, while industrial cyclicals appreciate in the middle of a recession, in anticipation of its end).
So if there are lessons here, I would say some of them are:
• Investing in Old Economy cyclicals is tricky, because you have to time your investment with quite a bit of precision. You will not be bailed out by rapidly growing revenue, net income and cash flow.
• Investing in New Economy stocks is also tricky, because the stocks can move up and down with disconcerting speed, while all along you are wondering if the trend line is up or whether you've chosen a lemon. These stocks move with great volatility around their trend line, based on psychology and momentum.
• Investing in New Economy stocks by buying and holding through thick and thin can be dangerous. Going into the 1973--1974 bear market there was a group of "one decision" growth stocks, the so-called Nifty Fifty, which were the New Economy stocks of the day. One of these was Xerox, priced at $64 on May 9, 1999, and $4.75 on Dec. 8, 2000. Needless to say, the Nifty Fifty have joined the Old Economy.
It often makes sense to leave both cyclical (Old Economy) and technology growth (New Economy) stock investing up to professionals, such as mutual fund managers. For individual stock investing I tend to favor stocks like large pharmaceuticals, whose technology is constantly refreshed by new drug discoveries. These companies publish quite a bit of relatively comprehensible information about themselves as well. In this group are such successful companies as Merck, Eli Lilly, Smithkline Beecham and Johnson&Johnson.