Are we in for another dot-com crash?
New investors might not be familiar with the lore. Here’s a deep dive into the lessons we can learn.
I’ve been a Formula One fan from a very young age. My father had an interest and barracked for Ferrari. As a rebelling daughter, I chose to support McLaren. Soon my interest outgrew his. With the advent of Netflix’s Drive to Survive came the annoyance that everyone around me was now a Formula One fan. Tickets sold out quicker (and were more expensive) and the commentary focused more on driver feuds than the racing. I will admit it was a bit of a childish attitude, but I found myself telling people that ‘I liked it before it was cool’.
The social media algorithms serve me copious amounts of Formula One content. A similar theme is followed. Many self-declared F1 fanatics seek the ‘lore’ behind a certain team, driver, relationship. They’ve only started following the sport in the last few years and don’t know the history behind many of the stories that have become lore.
I watch these videos with a cringeworthy smugness. I know the answer. I’ve was there. I watched the races or followed that season. Contemplating what it meant to jump on the bandwagon got me thinking about work and investing.
I came into investing later than my older colleagues. I haven’t experienced major market events to any real extent. I was in high school during the Global Financial Crisis and had no dog in the fight. I do have some advantages over investors my age. I get to spend my workday reading and gaining an understanding these infamous events. I try and get a sense of how investors reacted and the chain of events that led us to where we are today.
An influx of new people have joined the ranks of investors in the last decade as barriers have been lowered. They’re in the same boat. They don’t know the ‘lore’ of large market events and the crucial lessons that they taught investors.
Markets go through periods of euphoria and despair, and investors who understand these cycles, not just academically, but emotionally, are the ones that are able to build lasting wealth.
It is hard to replicate the experience of living through a full cycle. But it is worth understanding a few of these major market events that have become part of investing lore, and what they can teach us about becoming resilient investors.
This is the first of a three-part series into market crashes and what investors can learn from them.
.com crash
The .com crash occurred in the early 2000s. Just like every market bubble, people were calling it the ‘new normal’. In October 1999, the market cap of the 199 internet stocks tracked by Morgan Stanley was a whopping $450 billion. Total annual sales of the companies came to around $21 billion. The profit picture was bleak. They had collective losses totalling $6.2 billion.
This illustrated the collective delusion of the market. Investors collectively decided that everything that used to matter no longer mattered. It wasn’t earnings and cashflow that was important. It was pageviews and clicks. New metrics were invented by investors to justify the prices that were being paid for these companies. It worked for investors – until it didn’t.
All markets performed well during the late 1990s, but the speculative bubble was centred on the NASDAQ. This is the exchange where most technology and new economy companies traded. Between 1995 and 2000, the NASDAQ composite index rose 400%. It reached a Price to Earnings (P/E) ratio of 200.
As the market climbed, there was a profound sense that this time was different. There was a sense that the economy had entered a new phase. This is why the traditional way companies were evaluated no longer mattered.
The basic premise of this hypothesis was technological innovations and globalisation would continue to raise productivity. This didn’t happen. In most developed markets, the productivity seen during the 1990s decreased and started trending downwards after the tech bubble burst.
This notion that things are different is a common occurrence at the top of the bubble. Generally this is simply a way to justify for what is happening in markets.
The late 1990s market was also characterised by a surge of interest from retail investors. Dedicated channels like CNBC were playing everywhere and investing became a sport. Online brokers levelled the playing field and made trading much more accessible. In the US, 40% of individual investors with financial assets between $25,000 and $99,000 made their first stock trade after January 1996.
This might sound familiar. We saw an influx of retail investors in 2020 and 2021. Online brokers keep getting cheaper, offering free, or low-cost brokerage. A recent article in the Wall Street Journal revealed that among Americans with incomes between $30,000 and $80,000, 54% have an investment account, with half of those investors entering the market in the last five years.
As markets continued to climb, individual investors continued to pour funds into the market. Over the course of 2000, the stock market began its meltdown, and individual investors bought the dip by directing $260 billion into US equity funds.
So what actually happened?
In the late 1990s concerns grew that when the year 2000 rolled around havoc would ensue as computers wouldn’t be able to register a change to a new millennium.
Given the worries interest rates remained low. After the millennium passed without incident Federal Reserve Chair Alan Greenspan came out with a plan to raise interest rates. His rationale was concerns that irrational exuberance was taking over the market. The market did not take kindly to this. The NASDAQ peaked on March 10th 2000 – a level that it did not surpass again until April 23rd, 2015.
The market fell. And then it fell some more. The NASDAQ went down by 78% and hit a low in October 2002. While not as profound, the S&P 500 fell close to 39% over the same time period.
The lessons for investors
The first lesson for investors is that someone is going to be left holding the bag when speculative mania hits the markets.
There were many people that cashed out during the .com boom. That includes the companies that went public, and the founders and executives who owned shares. These were the same founders and executives who were going on CNBC and talking about the ‘new economy’.
Retail investors got left holding the bag. They bought into the hype.
The second lesson is a similar. Valuation matters. The internet related shares were outrageously priced. New valuation metrics were invented. Investors piled into the NASDAQ, trading at 200 times earnings with the justification that earnings didn’t matter anymore.
There can be long periods in the market where fundamentals get thrown out of the window. Remember, you are buying a company when you invest in the share market, and eventually the ability of that company to make money is what matters. What you pay for those future earnings matter.
A good example is Microsoft. Microsoft was a great company in 1999. It is a great company now. Despite being a real company that had a near monopoly on PC software, it was outrageously expensive and sold at 74 times earnings. After the .com crash it took nearly 7 years for the share price to recover. What you pay matters.
This is the first of a three-part series on defining market events and what they teach us about building wealth. The next part will be released in a fortnight, focusing on the Nifty Fifty.
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