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Monday, March 29, 1999

An Investment Opinion
by Alex Schay

Oracles and Auctioneers

Dow 10,000 has the prognosticators out in force again. It would have been great if the editors at Dow Jones had just decided to fix the Dow's odometer at 4 digits. In which case, after 9,999 it would have been reset to zero. Ahhh -- no messy divisor to deal with and a return to the "purity" of the original index. The new index could be called Dow II -- Back to the Future. In 1884 Charles Dow simply divided the sum of all the prices of the companies in his nascent index by the 11 firms that were in it (the Dow was first computed using the Dow Divisor in 1928). The new millenium scenario outlined above begs the question, "Would we hold the present average in such high regard if it were simply the average price of its current thirty members?"

Silly question, granted, but it lays bare the roots of the now enormous oak we call the Dow Jones Industrial Average. Nightly, every media organization in the nation feels compelled to "report" about the day's market activity, and the accepted token vehicle for this assessment is the Dow. This and most other reporting on equities does a great disservice to the public in portraying the market as a hyperactive race of upticks and downticks -- disconnected to any reality that we might be familiar with. (Although most TV viewers are returning home from a hard day at work for some of those blips.)

Anyway, tonight's column was not meant to be a Dow diatribe, but rather a look at market commentary in general. Watching a whole host of Dow "oracles" parading across financial news screens this morning had me scrambling to find a disembodied chapter from Victor Niederhoffer's semi-autobiography The Education of a Speculator. In my photocopied version of Chapter 3, entitled "Delphic Oracles and Science," Niederhoffer draws some parallels between the Delphic responses of the ancient world and the obfuscations of modern market commentary.

Overall, Niederhoffer notes that for thousands of years scholars have been attempting to uncover the secrets of the Oracle. What accounted for its purported accuracy and tremendous following among the Hellenes of the ancient world (such that after 500 B.C. most Hellenes placed the Oracle's foundation "in the earliest days of the world")? Niederhoffer presents the conclusions of Joseph Faltenras, a scholar of Greek life who conducted over 60 years of research on the subject. Faltenras classified all of the verified historical answers of the Oracle into categories. Here are the results: commands, 30%; statements, 40%; prohibitions, 25%; nonpredicitve future statements, 03%; and finally, clear predictions, 02%.

It would seem that the wisdom of the Oracle really rested on its ability to keep its mouth shut -- or at least not fill it with a mythical foot. Actual predictions were rare, and most of the rest of the statements were difficult to falsify. Niederhoffer provides some examples with their modern day financial market analogs (from actual media statements):

Typical Delphic Responses

Command: Where the old men have long taken baths, and where unwed maidens dance in chorus to flute accompaniment, in the halls of the womanish man, worship Hera.

Statement: The gods forgive all uncontrollable acts [said to a priest who got drunk and had intercourse with a woman].

Prohibition: Restrain yourself, Roman, and let justice endure, lest Pallas bring a mightier war upon you and empty your marketplace and you return home with loss of much wealth.

Nonpredictive future statement: If he [Kallistratos of Athens, who was fleeing a death sentence] goes to Athens, he will obtain the laws. [He went and was executed.]

Clear predictions: Honorius will have a glorious reign.

Modern Market Equivalents

Command: Reduce your investment in bonds by 5% of your portfolio and increase by 5% of your capital your present investment in precious metals stocks.

Statement: Volume is very bullish. The stock market rises on rising volume.

Prohibition: It is so far from its 5-day moving average (29) and its 200-day (18) that it's just too risky for my taste.

Nonpredictive future statement: We bough Fleming at 24. Fleming fell on meaningless news that the company may have to pay $100-$200 million in compensatory damages for breach of contract. The Fleming CEO called the ruling "absurd" and has filed an appeal.

Clear Prediction: Given ideal upside targets and these support levels, the Dow should fall at least 91.5, but no more than 98.3, from its high (of 3000).

In other news today, (Nasdaq: AMZN) shot up $10 9/16 to $149 5/8 after its effusive press release announcing the start of an online auction business. This announcement raises some interesting questions about barriers to entry in the online world. Most of the work on the subject thus far has failed to consider the ability of current online operators to leverage their business into other online segments.

Consider two competitors to eBay (Nasdaq: EBAY). Yahoo! and Excite's Classifieds 2000 both have a substantial base of users but so far have gone nowhere in their attempts to mount a challenge to the premier person to person auctioneer. Both competitors offer free listings for users. In both instances, the firms' business models are natural extensions of their strategy to grow their base of users through the provision of unique services. Neither has grown at anywhere near the rate of eBay.

This outcome is not only due to network effects at eBay -- where the value of the network grows exponentially as the number of members grows arithmetically (check out "Exploring Barriers to Entry for Internet Companies" at -- and switching costs for sellers increase as well. Consider the bottom line for success in the online auction business: (1) the ability of sellers to get the maximum possible price for an item, and (2) the ability of buyers to find what they're looking for. Auction buyers will have no problem jumping onto multiple networks to check for items -- but sellers need to make a basic decision. Where are they going to consistently get the most eyeballs, and hence the most active bidding environment for their goods (the highest selling prices)? At sites with lots of users and lots of transaction volume.

There's nothing spontaneous about any of this -- Amazon will not be able to convert all of its registrants into auction participants right from the outset. The chief problem initially is attracting the sellers, and that's why Amazon is engaging about 117 businesses that will run auctions on its site. (eBay has many "professional" sellers on its site, essentially using eBay as their storefront.) In my humble opinion, the auction move by Amazon is not the lay-up that the market is pricing in today. Yes, Amazon has very capable management, but there is some simple "Internet physics" that can't be blithely tossed aside. This topic probably deserves an entire column though -- so look for it in future installments of the Fool on the Hill.

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