Rebecca Cretney reviews the slide in tech stock values, asking if this a repeat of the Y2K tech bubble bursting or if this is just due to current day events.
In mid September, Apple was no longer worth more than the FTSE100. This statement implies that, at at least one point in time, it was worth more than all of the companies in the FTSE 100 put together, as will likely not have escaped most of our readers. In fact, the tech rise is probably a familiar theme to most of us after seeing the NASDAQ 100 grow over 77% since March1 as at the time of writing.
Then, on Thursday 3 September, we saw a fall in values. From that day to the close of play on Friday 11 September, the index fell by almost 11%1. Apple was the worst performer of the closely-watched FAANGs (i.e. Facebook, Amazon, Apple, Netflix, and Alphabet’s Google) losing nearly 15% of its value over that same period1. So what was happening with tech stocks?
For the last few months, some financial market pundits have been drawing comparisons between the performance of tech stocks in 2020 and between 1995 and March 2000, when the last bubble burst. So is this just another tech bubble bursting?
We don’t believe what was happening with tech stocks is a replay of the dot-com events 20 years ago, for three main reasons:
1. Valuations are very different
The valuations linked to today’s internet-related companies are very different from those that underpinned the NASDAQ 100’s rise from under 1,000 to over 5,000 during the dot-com era.
Then the focus was on unproven internet firms that might, over time, have become profitable. In the then new world order, it was not a case of looking at the fundamentals of a company. Instead, by 1999, promising dot-com companies could raise substantial sums of money via initial public offerings having never made a profit or, in some cases, realised any material revenue. Instead, the goal was to become as well-known as possible with as much as 90% of budgets spent on advertising alone. Growth trumped even the notion of profits.
As such, 1999’s top NASDAQ companies do not look anything like today’s tech giants, which are among the most profitable companies ever. And, while some intangibles form part of valuations, the fundamentals are there.
Recent research from Macquarie Bank stated that “new economy” companies in 2011 accounted for 38% of US company profits. Now, they are generating about 55%. Their share of revenue has risen from 29% to 40% over the same period, and their return on equity is 50% higher than that of “old economy” companies. In addition, it transpires that their margins are higher, pricing power greater and they are less leveraged.
Apple provides a good example of how valuations have not become disconnected from reality. Its valuations throughout 2019, starting at 11.4 and increasing to 19.7 times price/earnings1, could largely be attributed to future iPhone revenues alone. And, although the ratio has moved higher to around 33 times (as of 15 September), many still view the company as an opportunity given it is highly likely to come out with new products.
2. Millennium bugs versus a pandemic
While this is not an obvious reason to flag why things are different, it is no secret that the global coronavirus pandemic has changed the backdrop for company operations, as well as day-to-day life.
However, while there was no viral pandemic in the months leading up to the 2000 crash per se, I am old enough to remember the hype created by ’Y2K’, with the challenge that the change in date from 31 December 1999 to 1 January 2000 created, and the fear that computers would start to process data as if the date was 1 January 1900.
Many of you may recall that some feared the millennium bug could even see planes fall out of the sky as the clocks rang in Y2K2. This didn’t happen, not least as the industry had had years to overcome any problems. At least one source had predicted the issue as early as 19843.
Meanwhile, today’s tech stocks have been able to adapt very quickly to the new status quo in 2020. With hardly any warning, these companies showed that not only were they able to continue operations with very little change to their approach – apart from the location of their people – but their business models also saw a boon.
It’s a mark that shows how sustainable (and credible) the industry has become.
3. The different investment base case
The last main difference to note is that there is a very different base case for tech stock investments now versus in 2000, not least as interest rates were at very different levels. There are two sub points to this.
First, tech stocks offer the promise of large future financial gains, as opposed to substantial immediate cash flows, but their business models require access to cheap credit to grow. Now, of course, tech stocks have access to this cheap credit and, if comments by the Federal Reserve (Fed) and other central banks are to be believed, they are very likely to have access to this due to the low interest rate environment for a long time to come.
Second, low rates highlight another advantage to tech stocks in the shape of a lack of viable alternative for investors to seek return. In March 2000 – at the NASDAQ peak – the top end of the Fed’s funds rate range was at 6% and had been raised five times over the preceding eight months4.
Wind forward the clock to 2020, while the Fed raised rates in 2019, the range topped at 2.25%. The central bank then cut rates twice before the end of the year to 1.75%. Now the rate range is between 0.00% and 0.25%.
As a result of this, and since interest rates form the bedrock by which many asset types are priced, the search for yield has amplified and has prompted many investors to pile into stocks due to FOMO – the ‘fear of missing out’.
And as economic growth is unlikely to return with any strength (or interest rates rise any time soon) until a vaccine has been developed and distributed globally, a new acronym has surfaced for tech stocks in TINA or ‘there is no alternative’ for positive returns for investors.
While this doesn’t necessarily mean that the stocks are fairly valued, the dynamics and valuations are likely to remain magnified in a low-rate, low-growth environment, and the growth in stock prices should follow. In other words, even if tech was in a bubble, not all bubbles burst.
However, having outlined how time has marched on and that we don’t believe that the tech industry is about to reach the same nadirs of days gone by, it’s not necessarily all going to be plain sailing. Again, there are probably three key reasons for this:
1. Political pressures
The 2020 US election is a fascinating reality show, no matter what your political persuasions. And amid all of this is the view among politicians that tech companies have become too powerful.
This political pressure comes from all sides. And it is likely to amplify as some social media sites seem to be failing to stop political interference from Russia, China and Iran5 in the 2020 election. It also appears they lack the power to prevent the rise of controversial home grown activists, such as QAnon or Extinction Rebellion. And there are of course numerous other reasons why governments may curb their influence – as Trump did with the banning of TikTok over claims that it had helped ensure his Tulsa rally in June was a flop1. The reality is that the political perception of social media companies is now much more negative and their reach could easily be curbed. This is particularly the case when growth is achieved through mergers and acquisitions – an easy hurdle for politicians to put up.
2. Taxation
We have written before that government debt – as measured as a percentage of gross domestic product (GDP) – is now at levels higher than after World War II6. This places a burden on governments to find extra revenue to prop up their economies further and start to balance their books.
In July, the European Commission fined Facebook €110 million for providing “incorrect or misleading information” during its 2014 investigation of its deal to acquire WhatsApp7. And while there will no doubt be more fines, since more acquisitions have taken place, the set-up of tech companies means they avoid paying taxes from revenue raised locally, shifting the sources of those profits – patents and intellectual property (IP) – to countries with the lowest corporate tax rates.
In October 2019, the Organization for Economic Cooperation and Development launched a framework to allow countries to tax multinationals even if they did not operate inside their borders. While an agreement is still due – and the debate has raged for years – it is likely that a tax could finally be agreed or simply implemented piecemeal, as France has shown8. It is also a tax that is politically expedient as it will be popular to a nation’s business owners, and particularly those with bricks-and-mortar premises.
3. Is there a ‘where to next’?
Last, but not least, is the argument that organic growth could be flattening for many of these giants.
In the first half of 2020, propelled by the decisions to stay-at-home and lockdowns, Netflix – as an example – amassed almost 193 million subscribers around the world. However, the company has already recognised that the growth may tail off over a number of quarters – not just one or two.
This flattening growth scenario is likely to be common to many more tech giants. How many more people will be buying tech goods and services having rushed to buy ahead of the unprecedented numbers of people working from home?
Meanwhile, lockdowns have also forced many traditional companies to broaden their online footprint, which has led to further competition for companies that sometimes have very little to offer beyond IP and an intuitive platform. Remember Friends Reunited and Vine anyone?
At some point, we are confident that the pricing of tech stocks will return to more rational levels, or even move sideways, as earnings catch up and validate prices. Our reliance on the web is not about to change overnight. But we don’t know whether that time is now, or whether it has yet to come. Only time can tell.
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Sources: Nedbank Private Wealth and (1) Bloomberg; (2) Time Magazine; (3) Computers in Crisis by Jerome and Marilyn Murray; (4) Federal Reserve; (5) US National Counterintelligence and Security Center; (6) IMF; and (7) European Commission.
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Rebecca joined Nedbank Private Wealth in May 2004 having moved to the Isle of Man from Barcelona to pursue a course in Business Studies with the Isle of Man Business School. Rebecca was appointed to the role of investment counsellor in March 2019 to focus exclusively on the company’s discretionary investment management services.
She works closely with our teams of private bankers to provide support in advising our clients with integrity, and to give additional technical investment expertise where more complex portfolio requirements exist.
Rebecca is a Chartered Fellow of the Chartered Institute for Securities & Investment and a Chartered Wealth Manager.
Rebecca joined Nedbank Private Wealth in May 2004 having moved to the Isle of Man from Barcelona to pursue a course in Business Studies with the Isle of Man Business School. Rebecca was appointed to the role of investment counsellor in March 2019 to focus exclusively on the company’s discretionary investment management services.
She works closely with our teams of private bankers to provide support in advising our clients with integrity, and to give additional technical investment expertise where more complex portfolio requirements exist.
Rebecca is a Chartered Fellow of the Chartered Institute for Securities & Investment and a Chartered Wealth Manager.
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