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Top 27. Mar 22, 2000 10:11 AM

» JenL_2 - Puzzled Investors

Rande - Here's the online version of the 3/22 WSJ article you mentioned:

Puzzled Investors Seek the Real Economy As the Idea of Old vs. New Loses Potency

By JACOB M. SCHLESINGER

Confused? Who wouldn't be? One day, investors lunge from Old Economy stocks to New Economy issues. The next day, the seesaw reverses. On Tuesday, the Old Economy's Dow Jones Industrial Average and the New Economy's Nasdaq Composite Index both soared by more than 2%.

Much of the volatility reflects Wall Street's manic mood swings. But another, more fundamental influence is also at work. The economy has entered a phase of perplexing change, making investors increasingly unsure about where to look for tomorrow's winners.

For the past three years, rapid growth, cheap oil and easy credit have fueled across-the-board prosperity. Now, oil prices are three times as high as a year ago, and the Organization of Petroleum Exporting Countries, which is scheduled to meet in Vienna on Monday, is ambivalent about offering much relief. The Federal Reserve, meanwhile, is determined to slow the nation's economic growth. Tuesday, the central bank boosted its key interest rate for the second time this year and signaled its intent to keep doing so well into the spring.

The double whammy of rising oil prices and interest rates would, under the old rules, cause widespread pain. Indeed, some of America's most venerated blue chips -- from Procter & Gamble Co. to American Airlines parent AMR Corp., to U.S. Bancorp -- already have announced profit squeezes in recent weeks from higher raw-materials costs or rising interest rates. And a broad economic slowdown would pinch such companies further.

Thicker Insulation

Resurgent inflation or a recession would hurt the technology pioneers of the New Economy, too. But many of these fast-growing businesses appear more insulated from the vicissitudes of energy and credit markets. "Old Economy companies are all about physical assets -- oil matters because you've got a lot of trucks, and interest rates matter because you've got big plants and buildings," says Don Listwin, executive vice president of Cisco Systems Inc., the San Jose, Calif., maker and designer of computer-networking gear. "We're in the business of delivering intellectual property: Oil and interest aren't on the radar screen."

Cisco itself has no debt. In fact, companies traded on the tech-heavy Nasdaq Stock Market had a collective debt load last year equivalent to just 16.6% of their market capitalization, well below the 85.2% average for the rest of the stock market, says RFA Dismal Sciences Inc., a West Chester, Pa., economic consulting firm. That's because most high-tech companies can easily meet their capital requirements simply by selling stock.

And even if Fed Chairman Alan Greenspan succeeds in cooling the economy, demand for products made by Cisco and its counterparts will likely remain brisk, as Old Economy companies scramble to remake themselves by investing in computers, telecommunications and related products. "People are spending more and more of their capital budgets on Internet-related strategies," says Mr. Listwin. "If there's a slowdown, that isn't going to affect us -- customers will just squeeze old-world assets even harder."

Blurred Boundaries

But that doesn't mean New Economy beats Old Economy. It means the real economy is evolving. Cisco and other technology companies aren't just selling to the New Economy. They are also selling to Old Economy stalwarts looking to boost productivity. The more technology those companies buy, the more the line between Old and New Economy blurs -- and the better the old blue chips themselves can absorb higher costs. This interdependence is becoming clearer as the blizzard of business-to-business Internet ventures reshapes corporate purchasing.

In the past month alone, companies as diverse as the Big Three auto makers, agribusiness giant Cargill Inc., retailer Sears, Roebuck & Co. and a consortium of household-products makers such as Dole Food Co. and Gillette Co. have unveiled electronic marketplaces. A recent study by investment bank Dresdner Kleinwort Benson estimates that companies using such ventures could slash procurement costs by as much as 10%.

Goldman, Sachs & Co. economists say such "B2B" efficiencies will boost the long-term annual economic growth rate in industrialized nations by 0.25 percentage point.

But while this next phase of the Internet revolution promises greater efficiency, it also creates more uncertainty. Who will reap the gains from these new efficiencies? The long-established producers? Their longtime suppliers? The marketplace designers? Consumers? No one knows for sure.

Second-Guessing

Nor does anyone know how the outcome will influence policy makers. Dresdner Kleinwort Benson economists believe that the Fed and other central banks will ultimately end up slashing interest rates to offset Internet-driven price cuts. Goldman Sachs analysts think Internet-driven economic growth could push rates higher. "With so few examples in our history, there is very little basis for determining the particular stage through which we are passing," Mr. Greenspan told Congress last month. His own bewilderment helps explain why the Fed is raising rates in only quarter-point increments, even though it is nervous about the economy's fast growth.

The new sense of both opportunity and anxiety is evident in last week's mad dash by the Grocery Manufacturers of America to announce an electronic marketplace that will allow the trade group's members to buy supplies ranging from packaging materials to computers. It hadn't even discussed the idea until March 3, when the prospect was floated during a meeting of e-commerce executives at the trendy Tribeca Grill in New York. In less than two weeks, executives representing 50 companies, including Kraft Foods, Campbell Soup Co. and Nestle SA, agreed to consider upending decades of supply-purchasing practices. They decided to act fast, before one of the Silicon Valley dot-coms, the current darlings of Wall Street, moved in to create a similar marketplace of its own that might ultimately go public for billions of dollars.

"This is a way for us to keep more equity among what we call the real economy, the people who make things," says Bill James, a senior vice president of the grocery makers' group. "We wanted to make sure that there's a better understanding that in this so-called New Economy, the assets of the Old Economy are going to be driving the value."

The recent Nasdaq slump and the miniboom in the Dow industrials suggests that investors, too, think old-line firms have been oversold. Yet despite the recent market gyrations, Wall Street still believes much of the future belongs to the technology upstarts. Since December 1998, the stock prices of the technology component of the Standard & Poor's 500-stock index have more than doubled, while the noncomputer companies have, as a whole, seen their values tread water, says Bridgewater Associates, a Westport, Conn., money-management firm. As a result, companies that trade on Nasdaq now make up more than 40% of the market value of all publicly traded companies in the U.S., even though they produce just a fifth of all the country's output, based on calculations by RFA Dismal Sciences.

For all the talk of a high-tech bubble, there is a basic logic driving the divergence of market values: High-tech is where the growth is. During the past decade, high-tech manufacturing output has been growing about 40% a year, while other manufacturers have been poking along at less than 3% growth, according to Fed statistics.

And Fed economists have noticed an intriguing trend: Since 1995, the rise in the ratio of tech-stock prices to stock prices as a whole has tracked almost exactly the rise in the proportion of corporate capital spending devoted to high-tech projects.

Now comes a turn in the business cycle. Costs -- in the form of oil and interest rates -- are rising. If Mr. Greenspan gets his way, sales will slow. With competition as intense as ever, hardly anyone will be able to raise prices.

What About Profit?

The big question: Who can make money in that new, tougher environment?

Many New Economy companies can. Dell Computer Corp. is moving aggressively to serve the exploding demand for servers and Web site management services, and it estimates that "just 5% of what the market requires over the next couple of years is currently in place," says T.R. Reid, a spokesman for the Round Rock, Texas, company.

And these companies' productivity is rising so fast that they can make profits even if costs rise and prices don't. Like many computer companies, Dell's per-unit prices are falling. Still, the company's sales and revenues are expected to jump by about a third in the fiscal year ending Jan. 31, 2001.

Some skeptics doubt the Old Economy can do the same. Merrill Lynch & Co. analyst Heather Hay helped sink the Dow Jones Industrial Average by more than 300 points on a single day earlier this month by issuing a report suggesting that P&G's earnings woes weren't unique to the company, but were endemic in the household-products sector. During the past decade, those companies "have been able to offset rising raw material costs with cost reductions and efficiency increases," Ms. Hay says. "It doesn't appear they can do that anymore."

Body of Evidence

Yet there are also plenty of believers -- and evidence -- that the Old Economy can keep stretching out gains. For all the hand-wringing about profit squeezes, the consensus of analysts is for the nontechnology companies of the S&P 500 to report a healthy profit increase of 15.5% this year, according to First Call/Thomson Financial, an earnings-tracking firm.

And the Old Economy's growing embrace of new technology should help sustain those gains, especially as business-to-business e-commerce soars in the next few years. Earlier this week, Eastman Chemical Co. helped lift Old Economy stocks by saying that cost-cutting would lead it to higher-than-expected profit for the first quarter. It expects more efficiencies in the future by, for example, saving as much as 25% of the transaction cost on each purchase it makes from suppliers through Web-based exchanges such as ChemConnect Inc.

Yet the arrangement is a mixed blessing for the Kingsport, Tenn., company, which, like most manufacturers, is both a buyer of supplies and a supplier itself. Currently, Eastman Chemical's customers negotiate directly with the company and have access to only a limited number of alternative prices, an arrangement that allows Eastman Chemical to keep prices up. Chemical exchanges "will make the price of every chemical transparent, like the price of oil, for every buyer in the world," says Roger K. Mowen Jr., the company's chief information officer.

It is conceivable, then, that even specialty chemical companies will be reduced to being low-profit commodity suppliers -- and that the winners will be the companies that operate the new exchanges. Some of these dot-coms are expected to go public later this year, and "you can envision they'll have phenomenal value," says John Roberts, Merrill Lynch's chemical-industry analyst. "You can imagine, like AOL and Time Warner, one of these B2B companies buying an old-world chemical company."

A More Bullish Scenario

But there's another equally plausible, more bullish scenario for the Old Economy. Eastman Chemical, for one, has a Web strategy that goes well beyond just buying and selling on the Internet. It has become a kind of venture-capital company, taking stakes in more than half a dozen start-ups in the past seven months.

Eastman has even created its own dot-com -- ShipChem.com, an online service that will help other chemical companies, even competitors, with logistics issues, such as tracking supplies around the world. Mr. Mowen says he hopes to take ShipChem.com public at some point, and that it could reach a market value of as much as "several billion dollars."

That may seem odd for a small spinoff from a manufacturer whose own market capitalization is only about $3 billion. Mr. Mowen figures it's better to switch than fight. "Those who digitize their business are going to prosper," he says. "If you refuse to admit the New Economy's coming," he adds, "you'll get completely hammered."

Subscribe to WSJ online @ http://www.wsj.com

.....Jen

-- posted by JenL_2

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