By: Devan Robinson
“Men, it has been well said, think in herds. It will be seen that they go mad in herds, while they only recover their senses slowly, and one by one." -Charles Mackay
All-Time Highs and Corrections
After a brief all-time high rendezvous the S&P 500 has pulled back into a 10% correction.
It is normal to see a few corrections (-10% from high) and several pullbacks (-3-5% from high) in a normal year. Although it may not feel like it this is ordinary price behavior.
What happens next? Anybody's guess. I'd say Q4 will be just as interesting as the rest of 2020.
Tech Bubble 2.0?
Most remember the 2008-2009 recession. What came before that one? The Dot-Com bubble of 2000. The late 1990's was the dawn of the internet and stock-market hype was intense. Personal computers were invading our homes and investors frantically invested in any business with .com next to its name.
Company valuations were bid-up to epic proportions. It ended poorly.
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Valuations matter. I have ranted about this in the past.
Given tech's meteoric rally a few of you have asked if we are entering dot-com bubble 2.0? This idea has been tossed around financial media the past few weeks. I am skeptical for three reasons:
1. Valuations aren't actually that wild.
The core of the pundit argument is valuation. Below are the top-10 U.S. companies by overall value:
Are tech companies dominant at the moment? Absolutely. Is this a new dot-com bubble? It's possible, but I'm doubtful. Comparing today's valuations to the dot-com bubble are misguided at best and misleading at worst.
A quick-and-dirty measure of valuation is the price-to-earnings ratio (P/E Ratio). The P/E ratio is simply how much you are paying for $1 of earnings. At the height of the dot-com bubble the P/E ratio of the Nasdaq-100 (technology stocks) was 200. In the world of P/E a reading of 200 is incredible lofty. Investors in tech-stocks were willing to pay enormous prices for businesses.
In today's market all eyes are on Apple; the $2 trillion apex-predator of the S&P 500. What was Apple's P/E at the recent all-time high? 38. A far cry from the Dot-com era P/E of 200.
To frame it another way: Apple's stock price could rise another 500% and still not reach the heights of the dot-com bubble. It's a major stretch to compare the two.
Could we be entering dot-com bubble 2.0? Yes, it's possible. There could still be a long runway from here.
A side-note: Tesla's P/E ratio is 1,061. Five-times the height of the dot-com bubble.
2. Tech's dominance makes sense.
Hype ruled the day during the dot-com era. The poster-child of this excess was pets.com. Pets.com was the hype-stock of 1999.
During its first fiscal year (February to September 1999) Pets.com earned $619,000 in revenue, and spent $11.8 million on advertising. Pets.com lacked a workable business plan and lost money on nearly every sale because, even before the cost of advertising, it was selling merchandise for approximately one-third the price it paid to obtain the products.
In short: it's hard to stay in business without profit. Say what you want about Apple but they sell a LOT of iPhones with a ~60% profit margin/phone. In the words of Buffett: "Apple is probably the best business I know in the world."
Nothing about pets.com made sense to me. Tech's recent dominance makes perfect sense to me.
I think Microsoft's CEO, Satya Nadella, put it best during a recent earnings call:
We’ve seen two years’ worth of digital transformation in two months. From remote teamwork and learning, to sales and customer service, to critical cloud infrastructure and security—we are working alongside customers every day to help them adapt and stay open for business in a world of remote everything.
Technology was already creeping into our lives. COVID pulled much of that incoming progress forward in a few short months. Work-from-home and e-learning were already trends. Once the market saw the value of these products in a work-from-home world the tech-giants were rewarded.
Markets are incredibly efficient at pricing.
3. History doesn't repeat itself, it rhymes.
Significant market moves are rarely reruns of past events. Bubbles, hypes, and manias will always be present because they're human nature. Greed isn't going anywhere anytime soon.
Every month Yale University conducts a "crash confidence" survey. They ask both institutional and individual investors how worried they are about a market crash. The survey recently hit a peak:
Source: Bespoke Research
Investors are clearly worried about a crash. They haven't been this worried since July 2008.
I don't know if this survey panned out the way Yale envisioned. Yale found that investors, big and small, are notoriously bad at predicting crashes. The prior peak in crash confidence, July 2008, was the beginning of the greatest bull-market in history. In an ironic twist, the current high-reading of crash-confidence is a positive-sign for markets. The more investors anticipate a crash the less likely one will happen.
Bubbles are built on emotion and psychology. One of the hallmarks of a bubble is people don't see it. That's what makes it a bubble. There weren't legions of big investors and pundits publicly worried about housing in 2007 or dot-com stocks in 1999.
Dot-com 2.0 getting airtime is reason alone to be skeptical.
The world simply isn't that easy. I wish it were.
Enjoy your week,
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