Why the Internet Stock Bubble Refused to Burst

When Internet stocks and other market darlings such as cable and computer companies hit the skids early last week, a cry arose from the cobwebbed corners of Wall Street where things like dividends and profits are revered--finally, the curmudgeons could crow about reality setting in. EBay, selling at 8,000 times earnings, had been exposed; Net mania was over. By week's end, though, those who would deflate the bull market in profitless companies got a familiar lesson: bubbles die hard, and this one still had air.

After the NASDAQ dropped 5.6% on Monday, wounded highflyers regained their strength for the umpteenth time. "Tech and Internet enthusiasts are hard to keep down," observes Byron Wien, analyst at Morgan Stanley Dean Witter. So AOL, which went from $167 to $116 in a blink, was quickly back at $146. , poster child for Internet speculation, shot from $184 to $159 to--gads!--$210. With lightning speed the reversal was reversed, and what had been shaping up as a seismic shift in the market turned out to be just a sneeze.

Or was it? Not everyone has been quick to give up on the shift, which for more than a week had investors rotating into the stocks of chemicals, machinery and paper companies, which stand to benefit as the world economy recovers from the Asian flu. "What started two weeks ago started too fast and was too extreme," says Jeffrey Warantz, strategist at Salomon Smith Barney. "But it's not over." Warantz's research shows that it isn't just tech stocks or large consumer stocks like Merck and Wal-Mart that are rising now. Several weeks ago, 81% of the stocks that he tracks were lagging the gains in Standard & Poor's 500 by 15% or more. Last week the reading was down to 76%. That hardly points to a party to which everyone's been invited. Still, many believe this is the start of a trend that will see a greater number of stocks step up the pace, while those that have been so popular over the past few years slow down.

Indeed, long-beleaguered shares of small companies got a lift from the rotation and stayed strong even as investors returned to their Internet darlings. This broadening, if it persists, comes with great risk. Rarely does a major shift in investor thinking arrive without a dose of market pain. "Most of the Internet stocks have made their highs," declares Dick McCabe, market analyst at Merrill Lynch. He believes the industrial stocks will re-emerge as market leaders later this spring, following a wide pullback. If he's right, the fuddy-duddies may at last celebrate for a good long while--if, that is, by then they haven't joined everyone else and plunked their savings on the same five tech stocks.