Speech by SEC Chairman:
Remarks at The Finance Conference 2000:
The New Economy
by Chairman Arthur Levitt
U.S. Securities & Exchange Commission
March 6, 2000
Thank you for that generous introduction. It has been a great privilege for me to work with Congressman Markey over the years. His leadership and attention to so many of the issues affecting our markets have served both as a guide and a force towards a better marketplace. America's capital markets, and more importantly, America's investors, have been the benefactors of your diligence, your thoughtfulness, and your hard work.
America's marketplace is moving rapidly down the whitewater of evolutionary progress driven by the currents of competition and technology. Today, our capital markets are experiencing change at a pace and on a scale we've never seen before. New market entrants, new ways to invest, and new investors are changing the face and form of America's markets.
Electronic Communication Networks are challenging traditional trading floors. The nation's stock exchanges are considering shedding their long-held membership status. On-line trading has expanded the base of a powerful force in today's markets the retail investor. Institutional trading has increased the demand for greater liquidity, anonymity, and even new trading venues. Market participants are demanding more: twenty-four hour trading, immediate execution of orders, and lower costs.
Amidst this change, no longer can investment firms take for granted business or customers grounded solely in long-standing relationships. No longer can markets expect order flow based on tradition. No longer can companies cling to the comforts of custom. In today's economy, all markets and all market participants must respond to new rules and reinvent their roles not just to compete, but to survive.
These times of unprecedented opportunity and change also demand greater vigilance from investors. A new, heightened optimism is fueling an almost unbridled culture of entrepreneurship, innovation, and investing. But history has taught us that the greatest threat to continued prosperity is a loss of perspective.
There is still much we don't know about what drives today's economy and even less about where it's heading. During these formative times, all market participants must recommit themselves above all else to adding value and serving the investor interest. And, more than ever, investors must remain focused on what makes sound investing sense for their families, for themselves, and for a more financially stable future.
Adding Value in the Marketplace
Today it's fashionable to talk about the New Economy, or the Information Economy, or the Knowledge Economy. But when I think about the imperatives of this market, I view today's economy as the Value Economy. Today, adding value has become more than just a sound business principle; it is both the common denominator and the competitive edge.
In this country, we've always had a basically free market system. But, new developments are producing a fairer marketplace. The free market has given birth to competition and innovation. But, a free and fair market becomes the grandfather of value.
As barriers to improved pricing fall and impediments to competition are removed, investors are reaping the benefits of tighter spreads, lower costs, and faster execution. At the same time, new market entrants are challenging the assumptions and practices of the traditional exchanges. The genius of the market is being unleashed to create even greater opportunity and more vibrant competition.
The confluence of new competition unburdened by barriers to entry and rapid technological advancement brought to life by the spirit of innovation mandates that every market participant question how they add value.
Market intermediaries must be surveyors for new opportunities, new market niches, and new markets altogether. Firms and markets must seek out new ways to respond to a more informed and more demanding investor base. All market participants must explore new possibilities for applying the benefits of innovation to their own businesses and customers. Those that do not stand to be archived by the technology that surrounds them.
Responding to an Energized Investor Base
Technology the engine of the Value Economy is also providing retail investors with access like never before; access to on-line trading and web pages devoted solely to financial news; access to stock quotes and pricing information; access to corporate filings and financial disclosure. As a result, a new breed of investor more informed, more inquisitive, and more in touch with financial activity than ever before is emerging from the Information Age.
In increasing numbers, investors are directly involved in managing their assets, researching their investments, and making their own important financial decisions. Investors are becoming more than just the end customers. They are becoming a more integral part of the process of buying and selling securities. They have injected themselves into the traditional role of the middleman: developing investment strategies, analyzing trends, considering new opportunities. In many respects, they are changing the very nature of the customer-client relationship.
Consider what the rise of the retail investor has done to the marketplace: Lower trading costs, greater transparency, and more efficient pricing information. More and more, they want to know how and where their trades are executed and whether they've received the best possible price. Faced with a growing population of proactive customers and on-line investors, traditional brokers and investment advisors must constantly ask themselves, "How can I add value?"
Our traditional markets and new market centers must serve their customers in the most responsive and responsible manner. If investors believe that they are not receiving the most competitive quotes and pricing, they will go elsewhere. If investors believe that their orders will not be executed quickly or that their interests are being placed secondary, they will go elsewhere. If they believe that the quality of their trades is being sacrificed for any reason whatsoever, they will go elsewhere.
The retail investor like no other time is driving the marketplace. But that's only half of the equation. What is driving today's investors? What are we to make of some of the investing trends and developments today the surge of day traders, growing margin accounts, the rush to buy IPOs?
Progress, Prosperity, and Perspective
More and more, Americans are investing in our stock markets. And today, our markets are more a part of America's consciousness than ever before. Standing in line at the supermarket or the hardware store, you're as likely to hear about the Nasdaq's performance as you are Monday night's football score.
Much of today's heightened enthusiasm is understandable. This month marked the longest period of economic expansion in our nation's history. Steady growth, low interest rates, low inflation, and record employment have created greater opportunity and better lives for millions of Americans. Our markets continue to set new records.
But in the celebration of today's prosperity, I'm concerned that some of the basic but important fundamentals of investing are being lost on investors. Or, even worse, simply ignored. Unless investors truly understand both the opportunities and the risks of today's market, too many may fall victim to their own wishful thinking.
The reality is, there's a lot about today's economy that even the most savvy investment professionals and economists simply don't know or are still trying to figure out. But some investing principles remain timeless. Successful investors, through good times and bad, focus a vigilant eye on managing risk. Periods of promise and prosperity are not an excuse for us to let our guard down. In fact, it's times like these when we need to raise it even higher.
Now I realize that, in many respects, today's euphoria is nothing new; history shows us that heightened speculation has always accompanied innovative and dynamic times. Some even argue it lifts creativity and productivity to greater heights. But let's not forget the important lessons America's march of progress over this past century has taught us.
Take, for instance, the automobile industry. In the late 1920's, there were over 100 American companies vying for a piece of this new market. Today, there are only two U.S. automakers. Or look at the canal, steel, or railroad industries. Or, more recently, personal computers. In the end, only a very small number of the companies launched into these new and booming markets were left standing.
If past is prologue, many new companies rushing to market today will not be around for the long haul, perhaps not even a few years from now. Investors today cannot fall prey to an urge that tells them it's okay to suspend good judgment and invest with their eyes closed and their fingers crossed. It's never been more important to manage risk. And this means investors must research their investments and understand what they are investing their hard earned dollars in.
Often this process begins with the age-old question "What's a company's worth?" But these days, this might be the hardest question of all. Valuing a company has never been an exact science. But in today's market, does it even make sense anymore to look at a P/E ratio? Are some of today's companies really worth 1000 times nothing?
To justify today's valuations, some emphasize future potential and intangible assets that are hard to measure using traditional methods. They see technology's applications as infinitely scaleable its true asset value difficult to pin to one function or one market. But any way you look at it, many of today's valuations seem to defy traditional explanation.
The run-up of these valuations is largely the result of multiple stock splits and soaring share prices, fueled by an almost insatiable investor appetite. But much of today's activity in buying and selling stocks highlights an important difference between trading and investing. Trading is buying on the belief that the stock price will rise regardless of what the buyer actually thinks it's worth. Sometimes it can simply be a game of placing bets.
Investing for the long term means focusing on the fundamentals that make up a solid company no matter what the market environment, no matter how revolutionary change is. This means asking questions such as does the company have a vision, a business model that works, a strong management team, or a quality product. Is it well-positioned to embrace new technology or innovation? Does it use its resources to become a better company? P/E ratios and other traditional metrics may not be as helpful for some of today's Internet and technology companies, but these time-honored, fundamental questions will always have relevance.
A Rush of New Companies
Understanding a company's value could not be more relevant for investors when you consider what's happening in today's IPO market. Every day it seems another batch of companies is going public. Understandably, there's a big rush to "stake a claim" in the emerging Internet landscape. But what's behind the push to go public and what's driving the process of more and more IPOs?
With billions of dollars pouring into fledgling start-ups with no discernible track record, naturally investors are looking for big returns. As a result, many of these companies are groomed very early on to go public in record time. In this highly competitive market, some of them need quick and large injections of capital just to survive. But sometimes this race to an IPO comes at the expense of laying the foundation for a viable, long-term company. As long as investors stay hungry for public offerings, there will be even more IPOs.
Of course, I'm not saying that all of today's new companies have rejected sound business practices, or that some of them won't become industry leaders someday maybe even soon. Competition is the lifeblood of the free market. But finding the companies that will thrive in tomorrow's market demands even more work on investors' part today.
Researching Investments, Managing Risk
For investors, this means taking the time to research what they read and hear about potential investments. Unfortunately, these days it's not always just separating good information from the bad often, it's a question of gauging objectivity or bias. In many respects, a culture of gamesmanship has taken root in the financial community making it difficult to tell salesmanship from honest advice.
A lot of analysts we see on television recommending stocks work for firms that have business relationships with the same companies these analysts cover. And some of these analysts' paychecks are typically tied to the performance of their employers. One can only imagine how unpopular an analyst would be who downgrades his firm's best client. With all the financial information, advertisements, and advice out there, investors must be aware that not all of it comes without strings attached.
But responsible investing today means more than just researching investments. It means understanding and managing thresholds of risk which could not be more crucial in today's volatile markets. In a wave of optimism, too many investors, I fear, may be overextending themselves without carefully considering the consequences of their investment strategies.
These past few months, the level of margin debt has surged even faster than the stock market. Too often, investors are focusing on the upside without carefully considering the downside. Some investors have been shocked to find out that the brokerage firm has the right to sell their securities that were bought on margin without any notification and potentially at a substantial loss to the investor. Today, understanding the details of the loan agreement could not be more crucial, or the consequences of misunderstanding more severe.
Now, there's nothing wrong with margin buying as long as investors understand the risks. But few would disagree that it should be only one part of an overall investment strategy. No matter what the market environment, there is no better way over the long term to distribute risk than to diversify investments.
The free market driven by competition and innovation is creating not only an economy of greater value, but a marketplace of greater opportunity. Millions of Americans are now enjoying a standard of living that they scarcely could have dreamed of just a few years ago.
But, during these times of profound and far-reaching changes for our markets, none of us can afford to remain pigeonholed by outdated thinking or antiquated business practices. As we embark upon a new millennium, we must renew our focus on providing greater value and serving the investor interest. The efficiency and expanse of an unburdened open market is limitless. But in this era of progress and prosperity, it is even more important that we commit ourselves to balance, discipline, and managing risk.
Thank you very much.