This Stock Market Bears Some Resemblance To The Dot-Com Bubble. Is The Music About To Stop?
Bubbles don't burst in a day or a week. Once there's a puncture the air hisses out over months and years.
In the late 90s life was good on Wall Street and Main Street. Interest rates were at record lows which meant companies were able to borrow huge sums and then spend that capital on marketing and growth. Capital became so easy to come by that CEOs lost sight of, ya know, actually generating a profit. Employees everywhere were becoming overnight paper millionaires as the stock they had been issued for joining these internet companies was popping 100%+ when their company went public. Regular everyday people (aka retail investors) were taking part in the markets at a greater rate than ever before and everyone felt like a genius as stocks seemed to only go up. Everywhere you looked you could find high profile companies incurring net operating losses that were spending heavily to build market share. The Nasdaq rose over 300% from the beginning of 1997 to the end of 1999 and valuations got very stretched.
So what happened? The Fed aggressively hiked interest rates to try and stop the economy from overheating. When interest rates increase borrowing money becomes more expensive and that is a big problem for highly leveraged growth companies with no earnings. As we all know the Dot-com bubble ended up bursting and share prices fell dramatically… But not immediately. This is the problem with the phrase “bursting bubble”, it sounds immediate, like a blink-and-you’ll-miss-it event. When you look at the S&P from the turn of the millennium it becomes clear this bursting was anything but quick…
From peak to trough the S&P500 effectively halved in value over an excruciatingly slow couple of soul-crushing years. Every time the market bounced during those years you can imagine the hope investors must have felt as they looked at their deep red portfolios hoping this would be the start of a climb back to even before having to watch stocks sink further.
That was the S&P but there was even more pain if you were heavily invested in internet stocks: Between March and November 2000 most internet stocks had declined in value by an eye-watering 75% from their highs wiping out 1.75 trillion in value.
I wasn’t investing during this time (I was 15 at the turn of the millennium) but piecing together the timeline it’s clear that the market didn’t just pop and drop all at once. Pockets of the market rolled over one at a time like cascading dominos. The highly leveraged internet stocks sold off first before impacting the rest of the market as risk-off sentiment spread like an infection.
The common refrain is that history doesn’t repeat itself but it often rhymes. Let’s take a look at today’s stock market environment and compare it to the situation we just examined in 1999…
Low rates environment? Check.
Increased retail investor participation? Check.
Companies going public having never made a profit? Big check.
Growth as priority? Check.
Overnight paper millionaires? Check.
These signals on their own wouldn’t necessarily be cause for concern because even if we are in a bubble these things can inflate for years before topping out. What has me concerned are the noises the market has been making over the last month. Inflation is rearing its ugly head for the first time in decades and may force the Fed to raise interest rates to stop the US economy from overheating. Sound familiar?
Goldman Sachs have an index that tracks a basket of non-profitable tech companies (think Uber, Roku, Airbnb, Spotify etc). I rebuilt this index in Yahoo Finance but kept it equal-weighted and with hypothetical positions in each stock all started one month ago. Over the last month, these non-profitable growth stocks are down 16.39%. Compare this to the Nasdaq which is down 5.26% and the S&P which is down only 0.76% over the last month.
If (and it’s a big if) we are living through the same set-up that we saw going into the millenium, we will see the non-profitable tech stocks continue to plunge as investors slowly flee loss-making highly leveraged companies. If that happens the risk-off approach could spill into other sectors triggering a wider flight to safety. “Could” being the keyword here. Nobody knows what will happen next, but we must all be aware that the music could stop at any moment.
For my part, I’m de-risking my portfolio by reducing exposure to long tech. My only positions in tech now are Airbnb, Bumble, Shopify and Amazon. I’m increasing my holdings in cash-generating dividend stocks like Aviva and Kinder Morgan, I’ve opened a position in Centamin (a gold miner) and I’m prioritising UK equities over US. If the Fed can thread the needle with its belief that inflation is “transitory” while keeping rates low then great, game on, but if the inflation lasts into 2022 the market will find itself in trouble.
- CT
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