It is no secret that the tech industry has been on a roller coaster ride over the past few years. We have seen huge highs, like when the market hit an all-time high in December 2019, and devastating lows, like the crash that followed shortly after. So, is the tech bubble finally going to burst in 2022?
Many of Wall Street’s experienced investors are plagued by recollections of the dot-com crisis, and this year’s stock market collapse is giving them considerable déjà vu. Since 2022, the S&P 500 has decreased by 19%, and the tech-heavy Nasdaq has fared even worse, falling more than 28%. However, historical tendencies suggest that the stock market collapse may still be only 50%. For example, the Nasdaq-100 plummeted 78% between March 2000 and October 2002 as once-popular, but now primarily unsuccessful IT firms went out of business.
The dot-com crisis destroyed several tech sector darlings that had dominated the 1990s. Today, cryptocurrencies have an astonishingly similar trajectory in an industry that didn’t exist decades ago. In perhaps one of the worst sell-offs in the history of the developing market, the crypto market has lost around USD 1 trillion so far in 2022. And, of course, a brief but traumatic recession followed the deflating dot-com bubble. So is that the current direction of the markets?
A new period of growth over profitability
Markets and investors of the dot-com era were famously described as “irrationally euphoric” by former Fed Chair Alan Greenspan, and this dynamic was ever present during the 2010s. Both periods characterize Wall Street’s emphasis on expansion over profitability and the aggressive rise of retail investing. The best-performing stocks in both economic developments belonged to businesses with a growth-oriented strategy.
Take Priceline as an illustration. After its creation, the online travel firm experienced sudden success in 1999 and became public. After spending millions on advertising featuring William Shatner from Star Trek, the company soon piled up USD 142 million in losses in its first few quarters of operation, but investors didn’t seem to care.
All they needed was a share of the explosive growth from the business that would eliminate travel agencies. As a result, shares rose to nearly USD 1000 from the USD 96 IPO price (adjusted for a six-to-one reverse stock split), but as the market turned, the stock dropped 99% to a low of about USD 6.60 by October 2002.
Consider Peloton as a modern-day analogy. A work-from-home favourite during the COVID pandemic, the exercise bike manufacturer saw a 600% increase in stock value between March and December 2020 even though it continued to experience losses. But, of course, the stock subsequently collapsed, with shares dropping more than 90% from its peak as investors questioned whether the company that makes exercise bikes is worth close to USD 50 billion (its peak market cap).
According to George Ball, Chairman of Sanders Morris Harris, a Houston-based investment company, it’s evident that investors have been prepared to pay up for market share increases and projected future profitability, even in company models that haven’t yet demonstrated their ability to generate a profit.
“There was a strong, essentially unthinking assumption that a subset of investments would go up in price forever in the dot-com period, and in the current market run-up and decline this year. The justification, if there was any, relied on a very high rate of growth going beyond any reasonable assumptions of the bounds of scale, had no real basis in metrics, and had no real basis in logic,” he said. According to Ball, the “poisons” that ultimately caused a crash back then are the same as what the markets are currently going through.
What’s happening now?
Nobel laureate Robert Shiller defined a speculative bubble in irrational exuberance as “a situation in which news of price increases spurs investor enthusiasm, which spreads by psychological contagion from person to person, amplifying stories that might justify the price increases and bringing in a larger and larger class of investors who, despite doubts about an investment’s real value, are drawn to it partly.”
Tech observers are used to this craziness. COVID wreaked economic havoc in 2020 and 2021, but the IT industry was unaffected. Amid the lockdown, tech CEOs and owners got richer. Their enterprises expanded faster and were more profitable than others. Apple spent USD 90 billion buying its shares, nearly Kenya’s GDP. Amazon spent USD 50 billion in 2021 on warehouses, staffers, electric vehicles, cloud computing centres, etc. And then… The Nasdaq (heavily influenced by tech businesses) reached 16,057, then plunged on November 19, 2021. Currently, it’s 12,369. So, was this a “market correction” or a sign that this speculative bubble had burst?
According to quarterly numbers revealed by IT companies, the bubble has popped. Luke Gbedemah and Sebastian Hervas-Jones of Tortoise Media said the data shows a difference between companies that can “sustain an economic crisis” and those that may face existential decline. In addition, for the first time in the industry’s history, the companies’ combined real revenue growth rate was negative, and actual sales overall were lower than the year before.
Alphabet’s revenues grew 13%, but earnings plummeted 14%. Apple’s revenues rose by a hair, but earnings fell by 10%. Amazon’s sales increased 7%, but profits plunged 60.6%. Facebook had a bad quarter, with marginally lower revenues and 36% lower earnings. Microsoft’s revenues were up nearly a fifth, while profits were only up 2%.
In interpreting these numbers, the usual caveats apply: these are just one quarter’s results (though Meta has had two terrible ones); global supply chain problems and pulling out of Russia may have impacted Apple; and Amazon’s results may reflect its massive investment in Rivian, the electric vehicle manufacturer from which it has ordered 100,000 vehicles.
Investors formerly praised these companies for being different from regular, uninteresting corporations. Instead, these gigantic money-printing machines are headed into unknown territory, where they will push margins, expenses and privileges trimmed, workers fired, and efficiency found. Alphabet’s CEO urges employees to be “more entrepreneurial, working with greater urgency, sharper concentration, and more appetite than on sunnier days.” Similar sanctimonious exhortations are likely coming from other heavyweights.
Firstly, the era of “tech exceptionalism” – when investors and speculators praised companies and their supporters for being different from typical, boring corporations – may be ending. It is because these corporations are now no different from BT or Unilever.
Secondly, Microsoft’s case was misjudged because it blew the smartphone opportunity. Instead, it provided organizational computing infrastructure for organizations worldwide. For example, the NHS has 750,000 PCs running Microsoft OS and apps. Ditto for the UK government, massive firms, university administrations, and western SMEs. Microsoft’s cloud computing business is booming; though not glamorous or thrilling, it is a stable business.
Dot-com 2.0: tech stocks and cryptocurrencies
Any business that added “.com” to its name appeared to achieve success practically right away in the years leading up to the bubble, and recently it has been the same with “crypto” and “Defi.” These innovative technologies have attracted an influx of investors. Both then and now, the reasoning went something like this:
“Something is expanding quickly; it will continue to grow very soon.” The bigger fool notion then takes hold, individuals employ leverage, and when they can no longer sustain growth at a high level, the power is revealed, and the crash occurs, according to Ball. That’s the case with tech equities right now, as you’re aware, and it’s also the case with cryptocurrencies. The price drops in finished SPACs were an obvious indicator of this.
People are reluctant to acknowledge it, but psychology has a considerably more significant influence on stock values than the economy or profitability. It is psychology, and the psychology has changed for the worst,” the Chairman of Sanders Morris Harris said, adding that although “no one knows where the tech bubble burst is going to be,” he believes the Nasdaq may “very probably” fall below USD 10,000 in 2022. According to Ball, the best time to invest is probably when psychology and tech companies begin to increase.
Not everyone is anxious about the future of tech stocks
The chief financial strategist of Charles Schwab & Co., Liz Ann Sonders, tweeted that the forward P/E for the S&P 500 Tech sector is “nowhere near” the levels experienced in the period leading up to the dot-com bust. Even the crucial price-to-earnings (PE) ratio known as the Shiller PE ratio, which is cyclically adjusted, didn’t reach dot-com levels during the height of the stock market in late 2021. However, it is still higher than before the Great Financial Crisis.
Macroeconomic differences could cause an intensified recession
While the time leading up to the dot-com bust may now be startlingly similar, they also recall a remark sometimes credited to Mark Twain that may or may not be true: “History doesn’t repeat itself, but it often rhymes.”
In an interview with CNBC, Jeremy Grantham, co-founder and chief investment strategist of the Boston-based asset management company Grantham, Mayo & van Otterloo, stressed the macroeconomic differences between the dot-com period and current markets. He claimed that while the latest decline in tech stocks may be comparable to 2000, the impact on the economy now may be considerably worse.
“I’m worried that there are a few more significant differences from 2000,” he said. One of them is that the 2000 stock market crash only affected US stocks; bonds were excellent, yields were fantastic, housing was affordable, and commodities behaved themselves, according to Grantham, who noted that 2000 “was paradise” compared to today. The renowned investor continued, saying that, in contrast, the bond market recently experienced its “lowest lows in 6,000 years of history.” In addition, the cost of food, metal, and energy is rising, and the housing market is cooling, which might negatively impact the economy.
A Fed-driven downturn
However, experts claim that, unlike in 2000, the latest slump in IT stocks will not be the primary cause of a recession. Instead, the Fed’s efforts to combat the highest inflation in nearly four decades are the primary cause of economic suffering. The Federal Reserve has been increasing interest rates. That might not be good news for Main Street or Wall Street.
The Fed will boost interest rates to combat inflation because it is now running relatively high and is not merely a passing trend. But even though it will be acting appropriately, this is likely what will trigger a recession, Ball continued. The notion that the Fed will probably be blamed by Wall Street if a recession occurs is widely held. Even the former vice-chairman of the Federal Reserve, Randal Quarles, acknowledged that it would be difficult for the government to create a “soft landing” for the American economy, where inflation is controlled, but economic growth is maintained.
“I believe that we are entitled to a recession given the length of time we have experienced high rates of growth, affluence, and GDP gains. A cold shower brings about an understanding of reason and reasoning, and the popping of the bubble will do the same,” Ball stated.