Widespread fears of a new tech bubble are overblown
Despite some crazed internet valuations, 2014 is not a rerun of 1999
An employee walks past a logo of Alibaba Group at its headquarters on the outskirts of Hangzhou, Zhejiang province. The Chinese ecommerce giant is about to file for an initial public offering (IPO) in the US, with talk of a $170 billion valuation. Photograph: Reuters
Chinese ecommerce giant Alibaba is about to file for an initial public offering (IPO) in the US, with talk of a sky-high $170 billion valuation fuelling fears there is now a dangerous bubble in technology stocks.
Is it 1999 all over again? Has the bubble already begun to burst, and might this have wider repercussions for the financial markets? Or is all this bubble talk wildly overblown?
Not according to Marc Faber, who recently warned social media stocks “are more overpriced than the internet shares were in year 2000”. Faber is known as Dr Doom, of course, but more moderate voices, such as Blackrock’s Russ Koesterich, cautions internet stocks are “back to a world reminiscent of the late 1990s”.
Renowned hedge fund manager David Einhorn warned last week of the “second tech bubble in 15 years”. Goldman Sachs admits that similarities between the recent tech sell-off and that of March 2000, when the dotcom bubble burst, have “dominated client discussions”.
That sell-off was tame compared to the days of old. Even before last week’s rebound, the tech-heavy Nasdaq’s 9 per cent decline meant it fell just shy of an official correction. That it bounced as soon as it touched its 200-day moving average adds weight to the bulls’ contention that this was simply a healthy pullback.
However, this was no run-of-the-mill pullback. The Nasdaq suffered its worst week since summer 2012, while biotech stocks received their biggest one-day pummelling in 30 months.
Momentum stocks that have led the market higher were especially hammered. Twitter fell by more than 40 per cent from its December high; Facebook lost almost a quarter of its value in a matter of weeks; Amazon and electric car maker Tesla fell a similar distance from their 2014 highs.
In the UK, recently-listed online delivery service Just Eat fell from £2.93 to £2.25 in a fortnight; online retailer AO World fell from £2.93 to £2.25; another online retailer, Asos, fell from £72 to below £43; online supermarket Ocado fell below £3.30 after peaking at £6.23 in late February; fashion website Boohoo. com fell from 72p to a low of 45p.
It was an accident waiting to happen. Twitter, not expected to make a profit until 2016, was valued at more than $40 billion, and still trades at an indispensable-looking valuation. Facebook, worth more than $150 billion, trades on over 100 times earnings. Amazon, though strong and profitable, trades on more than 550 times earnings, or 57 times estimated earnings.
As for the aforementioned UK stocks, triple-digit price-earnings ratios are the norm rather than the exception, despite business models that looked far from revolutionary.
Then there are the prices being offered for private internet companies. Snapchat reportedly turned down a $3 billion offer; Google paid $3.2 billion for smart-home device maker Nest; Facebook paid $19 billion for WhatsApp, valuing the messaging service at $345 million per employee; dating app Tinder is reportedly being valued at $5 billion; there’s talk of $10 billion valuations for Dropbox and Airbnb.
Then and now
It’s obvious there are pockets of insanity in the tech market, but one must agree with former dotcom analyst Henry Blodget’s take: “Don’t insult the real bubble of the 1990s” by comparing it to today.
The Nasdaq, hovering around the 4,000 level, remains more than 20 per cent off its March 2000 high. It took almost a year for the Nasdaq to go from 3,000 to 4,000. In November 1999, it went from 3,000 to 4,000 in a month, and hit 5,000 by March 2000.
Today, the Nasdaq 100 trades on 21 times earnings, compared to more than 100 in 2000. The tech sector accounted for 13 per cent of the S&P 500 in early 1998, but that soared to 33 per cent by 2000, despite it contributing just 14 per cent of overall earnings.
Today, it accounts for 19 per cent of the index – almost unchanged since the bull market began in 2009 – and 19 per cent of its earnings. And for all the talk of UK dotcom madness, the technology sector accounts for just 3.3 per cent of the MSCI Europe index.
Similarly, the IPO market may look overheated, but it’s not like in 2000. In the first quarter of that year, there were 123 IPOs, more than twice as many as in 2014. In 1999 and 2000, 118 and 84 stocks respectively enjoyed first-day pops of more than 100 per cent. That happened on just six occasions in 2013, and on a handful of occasions this year. Market historian Mark Hulbert notes the average first-day return for an IPO in the first quarter of 2000 was 96 per cent, compared to 22 per cent today.
Back then, companies that simply added .com to their name averaged a 74 per cent gain within 10 days. Today, value investors own many of the biggest tech stocks.
Apple, for example, may be the most valuable company in the world but it trades on 13 times trailing earnings and 11 times last year’s earnings (and much less again, if one accounted for its $159 billion cash pile). Other tech behemoths such as IBM, Cisco, Microsoft, Oracle and Intel trade for between nine and 13 times estimated earnings.
Clearly, this is not 1999. However, it’s taking things too far to say, as some do, that the froth in various internet stocks is in some way acceptable as the heady valuations are driven by soaring revenues. Many refer to the work of US IPO expert Prof Jay Ritter, who notes companies debuting on the market today are six years older and have more cash than in the dotcom days.
To internet bulls, the Twitters and the Facebooks deserve their mammoth earnings multiples because they are growing so fast. The fact certain internet stocks have been punished for disappointing the market, such as Groupon and Zynga, is cited as evidence that investors are more discriminating than they may seem.
This doesn’t really stack up. Alibaba and Facebook and various other internet companies are profitable, but so what? That doesn’t mean they’re not wildly overpriced; it doesn’t validate the argument that traditional valuation metrics are in some way inappropriate for high-flyers; it doesn’t mean investors buying into the hype aren’t poised for long-term disappointment.
Ultimately, however, the bubbly valuations are confined to a narrow sector of the market. The worst one might say is that current action is, as David Einhorn put it, “an echo of the previous bubble, but with fewer large-capitalisation stocks and much less public enthusiasm”.
In 2000, the dotcom crash led to a US recession, a 78 per cent fall in the Nasdaq, and a halving of some of some of the world’s biggest indices. If the sell-off resumes, however, there’s little reason to think financial markets will be badly hit.
“If there were greater worries about the economy or other downside risks, then we should have seen the dollar rise, credit and swap spreads widen, and emerging markets under perform”, JP Morgan noted recently. “Correlations across risk assets should have risen. None of this has happen- ed.” There was “no breadth” to the sell-off.
As Alibaba prepares its flotation, investors can expect bubble talk and dotcom comparisons aplenty. But while there’s a lot of frothiness, talk of another tech bubble is overdoing it.