Giants like Facebook and Twitter have entered the public markets with huge valuations, and more tech companies are expected to follow in 2014. However, this is only stirring the debate on whether those popping champagne bottles are the precursor of a popping tech bubble. Some say that we are seeing the dot-com bubble all over again, while others are saying that we are in an economic shift, where tech is just a new way to do business. In this blog post, I will examine the common arguments on both sides.
The Bubble Argument
Just like the dot-com bubble of the late 1990s, capital markets are currently peaking at, or near, all-time highs. The Dow reached an all-time high of nearly 16,600 in December 2013. The NASDAQ hit almost 4,250 in January of this year, still short of its dot-com peak in March 2000, but significantly higher than any other time in recent history. Laurence Fink, CEO of BlackRock, the world’s largest investment manager, warns, “We have issues of an overzealous market again.” 1 Similarly, Jim Edwards of Business Insider argues that the stock market highs are a result of low interest rates.
People with money generally have a choice: save it in interest-paying, risk-free bank accounts or invest it in riskier assets that may pay more money over time. When interest is at zero, virtually any other kind of investment is likely to pay more because the risk-free alternative is so lousy. So investment asset bubbles get created. Stocks tend to go up.2
Moreover, Jesse Colombo of Forbes thinks that the government’s quantitative easing policy of lowering interest rates, in order to stimulate the economy, has created the bubble, and that as interest rates inevitably rise, the bubble will burst.3 Mr. Colombo also points to the U.S. stock market capitalization to GDP ratio, which Warren Buffet sees as “probably the best single measure of where valuations stand at any given moment.” 4 While the median ratio is 0.65, it is currently at 1.15, which is the second highest it has ever been, behind 2000’s roughly 1.5 ratio.5
Another big concern for people claiming that we are in a tech bubble is the fact that companies with little to no earnings have massive valuations. One measure of this is Robert Shiller’s cyclically adjusted price/earnings ratio (CAPE). The Wall Street Journal has stated, “The CAPE ratio currently stands at 25.2, which marks the metric’s first foray above 25 since December 2007. However, it remains far below its all-time high of 43.77 hit during the dot-com bubble in 2000.” 6 While Mr. Shiller views the current ratio as being high, he doesn’t think stocks will be in bubble territory until the measure reaches 28.8.7
The New Business Model Argument
On the other hand, some analysts are focusing on the differences between the current state of the tech sector and the dot-com era of the 1990s to conclude that we are not in a tech bubble. “95% of Nasdaq 100 companies are profitable now, vs. just 67% in 2000, and total earnings from in the company have tripled, from $60 billion to $180 billion.” 8 Not only are today’s public tech companies more profitable, there are also fewer companies going public, and they tend to be more mature than those of the dot-com boom. “According to the Wall Street Journal, in the whole of 1999 we saw 368 [tech] flotations, compared with just 32 by late October of 2013. The companies that went public in 1999 had been in existence for around four years, while they are on average 13 years old now when they float.” 9
There is also an emphasis on the difference in technology today versus the dot-com era.
The Internet and the ways people use and access it have been transformed in the past 14 years. In 1999, it was mainly through slow dial-up services using a desktop computer, now there is faster broadband and mobile access from phones and tablets. Web-based advertising has grown into a mature, viable business, and computing speeds support video and sophisticated gaming.10
Furthermore, Bryan Martin points to the difference in the way technology is being consumed today, especially in the workplace, as being a driver in the changing tech landscape. He argues that developments in consumer technology are significantly impacting how “back office technology” is being implemented, administered and delivered.
The purchasing power, or at least the decisions, of many organizations are increasingly influenced by employee demands. Instead of businesses choosing software from a particular company, or laptops from a certain vendor, they are making choices based on employee preferences, which in turn has increased the demand for secure and reliable technology.11
From the wealth of articles on the possibility of a current tech bubble, there seems to be a general consensus that we are not in one. Analysts are mentioning some warning signs, as mentioned above, but the thing about a bubble is that we are never really sure if we are in one, until it bursts.
Adam Smith famously stated, “[a]ll money is a matter of belief.” Applying this wisdom to an economic bubble, we can understand how bubbles come to exist. First, there needs to be a pool of believers (the “Inflators”), who convince the masses that some idea is the “next big thing.” If the Inflators expand market prices beyond the value of the underlying assets, then a new pool of believers will emerge. This new pool will consist of the “Deflators” and the “Destructors.” The Deflators’ beliefs can be a valuable tool in helping the Inflators to rationalize why they price certain assets at specific levels. On the other hand, the Destructors believe that they can make a lot of money by bursting the bubble, so they condition the market by instilling the belief of fear. Unfortunately, it is this fear that leads to quick, irrational decision-making that pops the bubble. The takeaway from this simplified scenario is that no matter where you stand in the tech bubble debate, you cannot stand in the shadows of fear, for it is fear that bursts a bubble. Without fear, prices will either gradually inflate or deflate based on the stronger side of the debate, and the Destructors will be unable to prevail.
John McCormick, BlackRock’s Fink Says There Are ‘Bubble-Like Markets Again’, Bloomberg (Oct. 29, 2013, 1:47 PM), http://www.bloomberg.com/news/2013-10-29/blackrock-s-fink-says-there-are-bubble-like-markets-again-1-.html. ↩
Jim Edwards, Here’s The Evidence That Tech Sector Is In A Massive Bubble, Business Insider (Nov. 3, 2013, 8:08 AM), http://www.businessinsider.com/evidence-that-tech-sector-is-in-a-bubble-2013-11. ↩
Jesse Colombo, Twitter’s IPO Is More Proof That Tech Is In A Massive Bubble, Forbes (Nov. 7, 2013, 3:54 PM), http://www.forbes.com/sites/jessecolombo/2013/11/07/twitters-ipo-is-more-proof-that-tech-is-in-a-massive-bubble/. ↩
Alexandra Scaggs, Nobelist’s Valuation Measure Draws Questions, The Wall Street Journal (Nov. 21, 2013, 12:06 PM), http://online.wsj.com/news/articles/SB10001424052702304791704579210273629381340. ↩
John Waggoner, No bubble in big tech yet, USA Today (Jan. 19, 2014, 10:14 AM), http://www.usatoday.com/story/money/columnist/waggoner/2014/01/16/no-tech-bubble-yet/4528879/. ↩
Mark Hawtin, ‘There’s no bubble in technology shares’, The Telegraph (Jan. 14, 2014, 4:55 PM), http://www.telegraph.co.uk/finance/personalfinance/investing/shares/10571806/Theres-no-bubble-in-technology-shares.html. ↩
Reuters, Investors wary as banner year for tech stocks evokes flashback to dotcom bubble and bust, Financial Post (Dec. 30, 2013, 1:01 PM), http://business.financialpost.com/2013/12/30/tech-bubble-stocks-investors/?__lsa=3227-967c. ↩
Bryan Martin, Tech’s second boom: What’s different this time?, Pando (June 19, 2013), http://pando.com/2013/06/19/techs-second-boom-whats-different-this-time/. ↩
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