Shift to The Equity Markets' Bubble
Shift to Bringing the Cases Together


Since the inception of digital computing, the application developers have economized on memory usage by presenting a year by two digits, e.g. 1999 as 99. Also, no one, including the developers, have wanted to be bothered with writing down the obvious, that is, the first two digits. This tiny and innocent exclusion has grown over the decades, with the proliferation of digital computing, into an exposure of computers, computer systems and embedded digital chips. The exposure manifests itself in the possibility of failures either to function properly or to produce correct results after the numerical year value advances from 1999 to 2000. In spite of early warnings, it took some years, about five on my observations, for the business community to wake up to the exposure. A certain part of the community, especially in the computing and legal spheres, have taken this as an opportunity to drum up the multi-billion dollar Y2K business by presenting the exposure as a serious threat. With the range of predictions, by those paid for making predictions, as broad as ever, no one actually knows how it will turn out. With that, and with the intensified publicity of "the year 2000 bug", a majority of business executives have started to run scared. In the course of 1998 and into 1999, the principle 'better safe than sorry' has become widely accepted. Money for Y2K projects has become no object. The legal profession has been inventing protective clauses for fending off any liabilities associated with Y2K. Many, if not all insurance companies but specialty insurers have stopped writing commercial liability policies on anything and to anyone even remotely associated with computers.

The following scenarios are to cover the possibilities for the developments that will start some time before, and unfold in full swing with the coming of the year 2000. I am also presenting my take by giving a general picture for the scenarios. If you are paying attention to the topic, you already know that each of the scenarios is being predicted by some of a growing number of visionaries.

(Y2K-1) A non-event scenario. There will be problems reported, some of them with casualties, but nothing that goes much beyond the established levels for the road, air, manufacturing, etc. accidents. The problems will be corrected or mitigated with acceptable work-around solutions in a matter of days or weeks or months. The prevailing assessments in the media will suggest that the billions of dollars spent on Y2K projects have been a waste. Not much credit will be given to those that have gone through expensive preparations. The underlying reasoning for this kind of assessments will be based on the fact that not all businesses and organizations have completed the preparations in time, and if the expensive preparations were indeed necessary, much more serious problems would have happened among those less prepared. The professions associated with computing will continue to be in good standing. The huge demand for them generated by Y2K will be largely replaced by other sizable needs, such as the euro conversions and the continuing advancements in technology. The legal profession as a business will move, by inertia, on any adverse situation and generate legal conflicts and proceedings from a thin air.

(Y2K-2) A mild consequence scenario. A number of very serious problems will be reported, with numerous casualties. The media will do their best to create an aura of calamity. In a matter of months, however, the things will get back to normal, the wave of media hysteria will subside, and historians will start their work. The professions associated with computing will be stressed to the limit. As the emergency works subside, things will start looking as in the Y2K-1 scenario. The legal profession will be pouring oil in the fire. It will be a major player and financial beneficiary for many years to come.

(Y2K-3) A calamity scenario. With the turn of the millennium, major problems start popping up. They will grow in numbers and unfold as a spiral into an economic and social breakdown. A struggle for physical survival will be the order of the day. The computing and legal professions, as many others, will stop their existence as a trade. The brutal force and the power of deadly weapons will be the law. Will you, fiction writers, step in please and paint a better picture for us while there is still some time left.

(CS-4) Please see the last section in this chapter.

Shift to Y2K
Shift to Bringing the Cases Together

The Equity Markets' Bubble

The way a market reaches exceptionally overvalued levels is a kind of the Ponzy scheme, a pyramid type of business transactions. This way of doing business per se is illegal. However, in this case it is impossible to put a finger on the culprit, thus, the proper authorities would not be able to identify and charge a business entity or an individual with the illegality. On occasion, a sense of trouble pops up. Then, of course, "speculators" or even a big shot financier would be blamed, but this is politics. In addition to this, the market assessments coming from the authoritative bodies are utterly conflicting and, by that, confusing to the market participants. The voices that bring the unprecedented over-evaluation or the pyramid analogy to public's attention are far and few between. If the question "Are the markets overvalued?" is put forth today in a public referendum or to those authoritative bodies, the majority of answers will probably be No.

Let's trace one corrective mechanism, or to put it differently, some relationships between economic variables that create a pressure directed towards normality. The book value of an enterprise is the dollar measurement of the undepreciated net assets in the enterprise at a specific time. This is the net cost of the enterprise to its owners. The price of a share in the stock market is a measurement of the enterprise's market value. In the present state of the stock markets, on average, the market value of an enterprise is much higher than the cost of creating and maintaining it. And the enterprise nevertheless remains viable for a long period of time. This means the enterprise is sufficiently profitable. This in turn translates into an attractive return on equity. In such a state, an incentive is in place to create a new enterprise with an output similar to an existing one. Here is an illustration of how it works. An entrepreneur establishes a new business, develops it to the point where its viability is accepted by others, and makes a public offering of shares. The costs to this point sum up to, say, $20 million; the market capitalization jumps to $120 million on the first day of trading. The smart cookie sells 49 percent of his shares into the market, pockets $60 million and still controls the business. This is a very simplistic and exaggerated example. But it is a text book stuff, isn't it. It is about a process towards production over-capacities. The process may work very slowly; however, as long as the price-to-book values remain high, the over-capacities continue to grow. They create the increasing pressure towards normality, mentioned above, through the growing over-supply and deflation, which is a companion in the process. A force, if it keeps increasing, will sooner or later overcome all other forces unless there is a counteracting force, and it is increasing, too. Here is a question to those who have been engaged in a modelling of market economies. Could you name, or provide references to a relationship between economic variables, or a mechanism (market or regulatory) that might provide indefinitely an equally increasing counterbalance to the increasing overcapacity? If you can think of one, we ought to have in mind one condition, namely, it should not be damaging to the economy.

In what way will the over-evaluation be resolved? Will the bubble burst and the markets plunge to the opposite extreme in a sling-shot fashion, losing 90 percent of their value in a matter of months? Or will the 'circuit breakers' implemented in the United States following the 1987 crash and the emergency financing by the International Monetary Fund, the World Bank and yet unaffected countries smooth the transition? As a saying goes, the stock market has fooled each and everyone of publicly selected and self-proclaimed gurus. We will not be sure until it happens. In many, if not a majority of the current prognostications, the return to historically normal valuations is not even in the cards.

Not daring to forecast ourselves, we'd rather formulate here the following possibilities.

(Market-1) A happy-go-round scenario. For years to come, the North American equity markets will keep ascending to new star-heights. And all the optimists, proud of themselves, will continue clapping, tapping, singing and dancing. And all the doom-sayers will wish they were dead. And you and I will be laughing at the preceding text in this Equity Markets' Bubble section.

(Market-2) A couple of perfect-world scenarios. The markets will slide gradually to normality. Or, they will behave for years in a vicinity of the current levels until the book value, dividend yield and price-earnings ratio have caught up. And the everlasting praise to the Federal Reserve Board chairman and other smart bodies will ensue.

(Market-3) A big trouble scenario. The markets will crash, with the crash extending into a trouble of the 1929 proportions. Shut up, Mr. Lev! We don't want to listen to another doom-sayer, we are fed up with them!

(CS-4) Please see the following section in this chapter.

Shift to Y2K
Shift to The Equity Markets' Bubble

Bringing the Cases Together

The two cases present some happenings in the same physical world. Therefore, if the developments of one case overlap in time with those of the other case, there will be interaction between them.

The timing of normalization in the stock markets is anybody's guess. With Y2K, on the contrary, we know well when the Year 2000 bugs, if any left, start popping up.

As we have noted, the duration of this bull market and the levels of over-evaluation are unprecedented. Thus, it may take just a little push to stop the bull. The unfolding of Y2K may well be such a trigger. If the two events overlay, the situation cannot be expected to be better. And other developments, foreseen or totally unexpected, might also come into play, further complicating the task of those at the helm.

Here is one more, promised scenario.

(CS-4) An overlay scenario. It is already outlined above. If this scenario materializes, historians will be arguing forever which of the two potential problems was a primary cause for the hardships. We assume of course there will be some historians left.

Post Scriptum to Case Studies. The iron-clad deadline for Y2K projects, imposed by the Supreme, allows us to make one prediction with confidence: we will see soon enough.

Shift to Y2K
Shift to The Equity Markets' Bubble
Shift to Bringing the Cases Together

Back to Table of Contents

Back to Home Page

The page Case Studies is released on January 27, 1999