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It’s been seven years—have computers taken over?

Posted: 10.13.08

In 1999, the Internet bubble began. Most people knew it was a bubble, laughed at the silliness of most of the deals, but a greed factor and feeding frenzy, fear of missing the boat and being left outside took over logic. Three years later the stock market crashed (relative to the run up in 1999) and didn’t get back to the pre-bubble level until near the end of 2003.

Today, the market is below the pre-bubble mark (9,300) effectively wiping out 10 years of growth, despite the tumultuous swings in between.

Share prices are based on expectation, and so they typically carry a value greater than the net-worth of the company. The difference between the value of the stock and the stock’s price is a function of the price-earnings ratio, or PE. A high PE means the investors expect great things for the company down the road. How far that road is varies from investor to investor. For some it’s 10 years, others five—it’s not an exact science.

If we look at IBM, one of the best run, most profitable companies in the world, we see its share price has more or less tracked the DJIA.

Last week, IBM said that it earned $2.8 billion, or $2.05 a share, on revenue of $25.3 billion, up from a profit of $2.36 billion, or $1.68 a share, on $24.1 billion in sales during the same period a year ago.

Analysts had forecast IBM to earn $2.01 a share on revenue of $26.5 billion. While IBM’s earnings topped analysts’ forecasts, sales fell short of the last consensus estimate, but several analysts were said to be in the middle of adjusting their revenue targets lower when IBM issued its earlier-than-expected
results.

IBM also said that its gross margins for the quarter rose to 43.3% from 41.3% a year ago.

Now, that’s pretty amazing, and yet IBM’s share price dropped from $103 on 06 Oct 2008 to $91.66 on 10 Oct 2008—a change of -11%. So even though IBM did really well this quarter, the investors think IBM’s prospects for the future (that five to 10-year road) aren’t so good. You’ll notice in Figure 1 that IBM got hammered at the Internet-bubble crash in 2002 too, and then came back to pre-bubble values very quickly, so back then, some investors must have decided they were wrong about IBM and changed their bet.

Figure 1: The DJIA reflects the mood swings of investors, but has little to do with reality.
(Source: Jon Peddie Research)


Figure 2: DJIA vs. IBM.
(Source: Jon Peddie Research)

So IBM, and others, who had nothing to do with the deregulation, the lack of assets in AIG, the dishonest brokers and loan offices, and the stupid panic driven home buyers, is having its stock price devalued because investors fear it won’t be able to borrow money to operate. IBM has $9.8 billion in cash reserves—that’s more than 124 of the 224 countries of the world have (e.g., Bolivia is at $9.2 billion) so how much borrowing does IBM have to do?

True IBM’s sales, like others, may suffer a slowness in growth, maybe even a flattening as consumer confidence wanes from all the bad news and the machinations of the U.S. congress and other countries’ national banks.

The world financial crisis now ranks with the 1987 stock market crash and the 2001 dotcom collapse in its impact on consumers, pushing their confidence levels sharply down this month. The U.S. consumer confidence index dropped 32 points in October—its largest single-month drop since the Consumer Attitudes and Spending by Household Index began in 2002. The index is at 37, compared with 69.2 in September. And this is going to have an impact on retailers as a result of the domino effect of the mortgage crisis, rising energy and food prices, higher unemployment, and now the investment and banking crisis. The lack of consumer confidence has eroded to a point where people are afraid to spend any money on anything and that will ripple back to the computer, IT, and other big industries.

Are computers to blame?

But so much trading is done automatically, based on complex and almost unfathomable algorithms that I have to wonder if the singularity has already happened and the machines are running the world.

Hedge fund managers, day traders, institutional investors, and retirement fund managers seldom make buy-sell orders anymore, or even the decision. They check the screen, sniff the air and press Enter. Then, within microseconds, a trade is made.

How are we going to get out of this mess if the computers are in charge? Where are the folks who wrote those programs? Do the hedge fund managers and investment bankers even know? Are we now at the mercy of a bunch of nerds? Can anyone see a way out of this mess?

Or is it over? Can’t we re-boot?