The tale of two tech ‘bubbles’

Rob Morgan looks back at his experience of the 1990s ‘dotcom’ mania and considers whether we are seeing another bubble in technology stocks today.

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  1. Rob Morgan

My formative year in the investment industry was quite a learning curve and I made a lot of the classic mistakes beginners make. In my defence, it didn’t help that that stock markets were undergoing a once-in-a-generation ‘euphoria’. It was 1999, the ‘dotcom’ bubble. A time forever etched in my memory due to the magnitude of stock market moves and the lessons it taught me.

There was nothing fancy about my job, which to be honest I fell into after going travelling. I was picking up the phone to customers and answering routine investment queries, but it did give me an immediate insight into investor sentiment. What was unusual, though I didn’t quite realise it at the time, was the level of interest among the general public towards investing – and in technology shares in particular – which had grown to reach fever pitch.

By the late 1990s, there had been strong growth and market conditions in western economies for some time, confidence was high, and investing was popular. The 1980s heralded privatisations such as British Telecom and British Gas, which led to widespread share ownership. A wave of ordinary savers with building societies and other mutual organisations were also landed with shares as they went public. PEPs, the forerunners to ISAs, were popular for keeping stock market investments out of reach of the tax man, and a ‘single company PEP’ allowance even incentivised the ordinary investor to hold individual shares. Funds became popular too and a swathe of discount brokers capitalised to provide information and offer discounts on their initial charges.

Then an investment story so alluring came along that the popularity of investing turned to a clamour: The internet. The worldwide web promised to rip up the business world and with it the rules of investing. No longer were companies confined to a physical location. Through cyberspace, they could sell anything to anyone anywhere. It meant, in theory, anyone could set up ‘.com’ business to try and dominate a given area. All they needed was start-up capital, which was suddenly in abundance, and a convincing pitch. Every week it seemed another .com or tech stock listed on the US or UK stock market to great fanfare.

Upon learning about my new job, a surprising number of my friends and acquaintances would become interested and want to discuss the latest trends. Initially, this was something I wasn’t quite ready for as I was still learning the ropes. Some would even boast about fortunes they had acquired in various obscure shares. My ambivalence turned to intrigue, which turned to excitement. It seemed investing was as easy as finding the latest trend and jumping on it!

Bursting point

Speculative ‘bubbles’ are really quite rare. Investment commentators are often quite quick to jump on overvaluations in certain areas and casually drop the ‘B-word’. But in 1999 there was a bubble for sure. One to rival tulip bulbs in 17th century Amsterdam (if historical descriptions are to be believed) and the ‘South Sea’ stock mania of Sir Isaac Newton fame. "I can calculate the movement of stars, but not the madness of men," Newton is said to have uttered after he lost his fortune.

Between 1995 and its peak in March 2000, the Nasdaq Composite stock market index (the US index of mainly tech stocks) rose five-fold and reached a price-to-earnings ratio of 200x. The meteoric rise in the index hid some even more extraordinary price moves in individual companies, some of whom rose 10 or even 20-fold in the space of a year or two.

At the time, the concepts of profitability and balance sheet safety were increasingly seen as antiquated and traditional financial metrics were assumed to be largely irrelevant. They were for ‘old economy’ businesses without an internet presence. The rules of the game had changed in investors’ minds, and online businesses were thought to be best measured by click rates, market share or ‘mind share’ – in other words brand awareness. It was presumed if these statistics were strong then profits would follow in time. At the height of the boom, there were dotcom companies that went public by listing their shares on the stock market via an IPO (initial public offering) without even having produced any material revenue, let alone made a profit. But it didn’t stop the share prices doubling, tripling or more on the first day of trading.

Here in the UK, new funds emerged to capture the trend, some with enticing and exotic names. Among a rash of opportunistic launches, Gartmore ‘Tech Tornado’ Fund sucked in a few investors with its aim to capture “a period of hyper-growth that technologies experience just as they reach their full potential”. Sadly, many investors forgot the rules of diversification and were only interested in owning the latest fashionable shares or funds. It couldn’t last. Tech Tornado and its peers wreaked havoc on portfolios as the whole sector nosedived. The inevitable spectacular crash that follows a speculative bubble started in March 2000 and the Nasdaq lost nearly 80% of its value by October 2002.

As with most bubbles, investor sentiment turned gradually at first and then gathered pace quickly. In early March 2000, US Federal Reserve Chair Alan Greenspan announced plans to raise interest rates, which immediately led to some volatility as investors digested how this might affect borrowing costs for companies and, in particular, cash-hungry technology businesses that needed to continually spend on advertising. Initially, the market shook this off, but the negative news flow continued. Japan entered a recession, which put a dampener on all markets with tech stocks disproportionately affected. Meanwhile, several newspaper and magazine articles warned some tech firms risked running out of money before they could turn a profit and that their demise was inevitable. Venture capital funding dried up amid increased scepticism, confidence was eroded by strings of bankruptcies and some major accounting scandals shocked investors including the notorious Enron in October 2001.

Fortunes accumulated in tech shares and funds were decimated for those who remained invested. Then, after many years when many people had vowed never to return to the sector and scarring was widespread, tech started performing again, and some shares even lived up to the original hype – Amazon being an obvious example as it went on to dominate e-commerce. Investors resilient enough to hang on did eventually recoup their losses but it took a long time – the Nasdaq regained its dotcom peak after 15 years. In the meantime, many individual businesses were wiped out. The lesson: be wary of waves of speculation. You might make money in the shorter term but the longer it goes on the greater the risks become, and you too could suffer a ‘lost decade’ with your investment.

Chart: £1,000 invested in the technology sector 1991-2020

Source: FE Analytics; chart shows performance of the Investment Association Technology & Telecommunications fund sector average since inception 16/07/1991 to 31/08/2000. Past performance is not a reliable guide to future returns.

Today’s tech sector

Today we are witnessing a technology sector in vogue once more. Like catwalk fashions it seems investor preferences move in cycles, but can we really say this is the Tech Bubble 2.0? Back in 1999, many tech stocks were pure speculation. Some barely had a viable business plan, let alone a record of generating earnings. Many were burning through cash unsustainably and virtually all of them had astronomical valuations attached.

Today’s technology sector is a different beast. The world’s largest businesses are tech companies, and although they are expensive, they have largely delivered on their strategies, met earnings expectations and appear to have many years of strong growth in front of them. The culture of ‘get big or get lost’ may have waned in some investors’ eyes after the nineties bubble burst, but it lived on in Silicon Valley and Seattle to the great benefit of some of the companies that survived. They have lived the dream of harnessing the ‘network effect’ garnered through significant scale. Others weren’t even around then, of course, notably, Facebook didn’t get going until 2004 as the concept of social media gained traction much later.

Today’s big tech firms are also resilient. The likes of Apple and Microsoft generate huge amounts of cash and are potentially able to deploy that in whichever direction they want to maximise growth. They are formidable businesses that deserve a premium rating, especially now that Covid-19 has accelerated some of the trends towards increased digitalisation and e-commerce. In a world where so many businesses models are being challenged, tech stocks provide reassuring durability. But how much of a premium is justified? The five largest stocks, Alphabet, Amazon, Apple, Facebook and Microsoft, account for 24% of the S&P 500’s market capitalisation, a record high.

To take one of the more extreme examples, electric vehicle giant Tesla is valued at over 200x its earnings, based on consensus 2020 estimates. Tesla lies at the intersection of the digital and green revolutions, which we believe are this decade’s defining trends, but expectations surrounding its future growth and the execution of its ambitions are certainly elevated. Apple, meanwhile, comes with a less demanding p/e rating of around 40x, though many consider this to be expensive given its maturity. Six months ago, it was 20x so investors are now paying a large premium compared to the pre-Covid price, and the benchmark for the smartphone upgrade cycle as 5G is rolled out is set high. Incredibly, Apple is now worth more than all the companies in the UK’s FTSE 100 combined.

Both Tesla and Apple shares have also been popular of late partly due to a somewhat tenuous reason: a stock split. Tesla split its stock 5-for-1 and Apple 4-for-1 in order to make their shares more affordable to small investors. This does nothing to increase the value of the companies – investors get several smaller slices of the pie instead of one big one – but it seemingly had the desired effect as shares in both companies increased as the split occurred. It seems that lots of investors are allocating money to these names without regard to valuation, which is indicative of more euphoric conditions. A lower valuation on weaker investor sentiment is an increasing possibility for these stocks, albeit we are a long way from dotcom mania when there was barely any foundation for valuations at all.

Is now the time to turn more negative on tech or should investors keep partying like it’s 1999? It’s impossible to say when the outperformance might end. Trends can take on life of their own when investors are less discriminate about the price they pay. Several investments on our Foundation Fundlist have benefitted substantially – notably Scottish Mortgage Trust, Baillie Gifford Positive Change and Allianz Technology Trust. Our suggestion would be to be wary rather than unduly worried but to always remember expensive investments are often extremely volatile as perceptions can change dramatically. We also reiterate our suggestion that investors maintain a balanced portfolio in case of a shift in sentiment.  

Past performance is not a reliable guide to future returns. This website is not personal advice based on your circumstances. No news or research item is a personal recommendation to deal. Investment decisions in fund and other collective investments should only be made after reading the Key Investor Information Document or Key Information Document, Supplementary Information Document and Prospectus. If you are unsure of the suitability of your investment please seek professional advice.

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