The Market Needed A Dose Of Reality...

Welcome to the start of the first major market correction of the New Economy. The correction in price may not be over, but a correction in expectations has already occurred. Despite the recoup on Turbulent Tuesday, a 13.6% fall in the Nasdaq in three hours, triggering margin calls all the way down, was enough to give pause to even the most speculative day trader. Real earnings suddenly matter a lot more than dot-com dreams. A long-overdue rotation looks to be under way that reflects a strong shift to quality. It is a healthy wringing out of excess speculation. But while a return to more rational valuation is to be applauded, the violent market gyrations are a reminder that the New Economy has by no means put an end to volatility.

Markets overshoot, of course, and the New Economy brings new temptations. A business world driven by hot technologies and innovations is one in which investors need to place lots of bets. It's impossible to know exactly which models will succeed or which technologies will get traction. Whipped up by the Wall Street hype machine, it is easy for average investors to get carried away, buy into initial public offerings at extravagant prices, and bid up certain Net stocks to ridiculous heights. People begin to accept silly notions of valuation, and high-tech stocks soar beyond any reason. Overshooting on the upside is always a danger in a technologically vibrant economy.

So too, perhaps, is overshooting on the downside. In recent months, venture capitalists and professional investors have quietly decided to move out of many business-to-commerce dot-coms that show few prospects of profitability anytime soon. Funds have been flowing into more promising business-to-business startups, Net infrastructure companies, and virtually all New Economy stocks showing real earnings. Safer Old Economy equities that have traditionally turned a good profit have also attracted professional money. But day traders and individual momentum investors continued to play fast and loose, keeping many high-tech stocks unreasonably high even as the pros retreated. That meant that when the break came in the markets, there was little support and prices fell like stones. On Tuesday, it was scary, perhaps scary enough to begin tempering the excesses of momentum investing.

The truth is, the Internet has been in an unreal world, and investors have been willing participants. Eternal verities of capitalism concerning competition, information, and valuation have been ignored. All the hype hid the questionable practices upon which many new dot-com businesses were based.