We have likened the high-tech sector to either babies in diapers or kids in short pants, depending upon their stage of development. When a new virus enters the atmosphere, the little ones are threatened far more than the mature sectors, whose immune systems are fortified by real assets that can be collateralized. The big swings in the dot.coms are the result of new, unanticipated threats coming from out of the blue, with the rebound and new highs being reached when the threats are quashed. Last year, on June 23, we noted that the NASDAQ had gone into a steep slide the previous afternoon, falling 62 points to 2580. The start of the slide timed almost to the minute of an AP report stating that a majority of a commission established by Congress indicated the Internet could not avoid taxation forever. None of the business pages made the connection. One of the positive aspects of Arizona Sen. John McCain’s candidacy was his vigorous opposition to such an idea, while Texas Governor George W. Bush has seemed vulnerable to the arguments made by state governors that e-commerce would dry up their sources of revenue. A more basic political pressure has been gathering from those brick-and-mortar businesses that genuinely are threatened by e-commerce and will use their clout to at least slow down the process of creative destruction.
Given that the NASDAQ is being hammered relentlessly while the Old Economy stocks soar, the conventional market analysts simply are asserting that money is rushing out of the high-tech sector and into the oldline stocks. Such cash-flow arguments make no sense to us. What is really happening is that the political forces of the Old Economy finally are having some success in throwing restraints on e-commerce. The simplest way to see that is to imagine Amazon.com steadily destroying Barnes&Noble as the company has to drag its bricks and mortar behind it. If Amazon can be slowed down, Barnes&Noble has breathing room. It is not the case that e-commerce is sucking the capital out of the economy and leaving little for establishment enterprises. There would be plenty of capital to go around if the Federal Reserve were not favoring e-commerce by trying to slow the aggregate economy with higher interest rates. The dot.coms shrug off high interest rates because as infants, they live on equity, not debt.
The Fed now sees this, as demonstrated by the inverted yield curve and the record advances of the Internet stocks up to ten days ago. Ratcheting up the funds rate was hitting the seniors without touching the juniors. So we get rumors and more rumors that the Fed will hike margin requirements, now 50%, to some higher number, which would hit the juniors far more than the seniors. This alone, though, could not cause the NASDAQ swoon we have been seeing. The big brokerage firms all have lists of stocks they will not margin at any level. And if the dot.coms are not harmed in any real, palpable way, the markets would find a way to get capital to them. As we indicated Tuesday, it is the patent issue that has come into the market, a hideous virus that could destroy the infant in the cradle. It was clear enough on Monday that the statement from President Bill Clinton and U.K. Prime Minister Tony Blair -- that all scientific data on the human genome “should be made freely available to scientists everywhere” -- had squashed the biotech stocks. To the market, the idea of the sharing of “free ideas” sounds even worse than an end to patents. It is a “mommy” idea that we equate in the extreme with Maoist collectivism. It is one thing for the children to share equally in the ideas generated by Mom and Dad around the dinner table. It is quite another to have junior share the money from his paper route with his lazy siblings. Very soon, there are no papers delivered and there is nothing to be shared.
We hope you have had a chance to read the Sunday NYTMagazine article by James Gleick, who advances the anti-patent case, which argues that the torrid pace of e-commerce patenting is slowing down innovation, by making it difficult for the new kids on the block to build on “ideas” that should be common property. Lawrence Lessig, a Harvard professor and expert on cyberspace, although clearly not in finance, says of the patent frenzy: “This is a disaster... a major change that occurred without anybody thinking through the consequences. In my view, it is the single greatest threat to innovation in cyberspace, and I’m extremely skeptical that anybody’s going to get it in time.” Amazon’s Jeff Bezos is among the bad guys of the piece, for insisting on patent rights that Gleick seems to think should be readily available to Barnes&Noble, just as the Supreme Court said Albert Einstein could not have patented E=mc². As Don Luskin of Metamarkets.com tells me in an e-mail today: “Why should Barnes and Noble be able to instantly confiscate the idea of ‘one click’ ordering, which took Bezos’s risk-bearing to produce in the first place? Established companies have a great advantage in the form of their franchises, which include marketing power. A newcomer like Bezos has to create his franchise and his marketing power from scratch. If Barnes and Noble can just imitate every innovation of Bezos, then how can a newcomer have a chance? The patent is the only hope an upstart has.”
Another e-mail response is from my cousin Bill, a DC patent lawyer for almost 30 years, who sums it up crisply: “Patent law has never been busier. The Court of Appeals for the Federal Circuit, which was established in the early 1980s and now hears all patent suit appeals from the federal District Courts, is very pro-patent. Previously, many of the federal Circuit of Appeals were notoriously anti-patent. And, the commercial sector has taken notice. On the importance of obtaining patents for Internet ‘ideas,’ the easy answer is that U.S. law does not provide for obtaining patents on mere ‘ideas.’ U.S. law defines patentable subject matter as any new and useful process, machine, manufacture, or composition of matter, or any new and useful improvement thereof. Now consider Internet-related ‘inventions.’ Such comprises hardware, e.g. an article of manufacture; software, i.e. a process or, if on a machine readable medium, such as a disc, e.g. an article of manufacture; or a method of doing business, such as e-commerce, e.g. a process. The universe of patentable subject matter is rapidly expanding. Patents have proven to be invaluable for expanding the body of science and the useful arts. This has been demonstrated in comparing the prosperity of highly industrialized countries with strong patent systems with that of less industrialized countries with weak patent systems. Arguably, patents should prove to be beneficial to expanding Internet-related technologies.”
Market “corrections” in the Internet stocks will happen from time to time, either as bolts from the blue, a la Clinton & Blair, or as creative threats from those forces in the economy that have most to lose -- including coalitions of brick-and-mortar operations that are on the way out and mature high-tech outfits that have gotten themselves on top early and would like to pull the ladder up. This, incidentally, was the nature of the coalition that pushed through Smoot-Hawley in 1929. They are forces to be reckoned with as you ponder your portfolios.