Tech Bubble? Don’t Believe the Hype…
It’s been a pretty ugly spring for technology stocks.
Take the tech-loaded Nasdaq, for example…
Having hit its 2014 high of 4,371 on March 6, the index has since dropped to 4,040 – down 7.5%.
The slide has some analysts doing their usual fearmongering, talking about another tech bubble. And they’re wondering if we’ll see a similar situation to the calamitous explosion of the dot-com bubble in 2000.
“It’s Official: We’re in a Tech Bubble,” declares Steve Tobak in Fox Business.
“Evidence That the Tech Sector is in a Massive Bubble,” states Jim Edwards in Business Insider.
“When Will the Next Dot-Com Bubble Burst?” asks James Heskett in Forbes.
Are they right?
I say, “Absolutely not!”
Here are three reasons why…
Reason #1: We’re Not in 2000 Anymore
The main difference between the dot-com days and the current tech selloff is the maturity and makeup of the market.
Consider that before the dot-com frenzy took hold, the euphoria came largely from one industry trend: the internet.
Today, we still have tech sector exuberance, of course… but it’s dispersed across several industries instead.
In other words, today’s tech sector is much more diverse than it was 15 years ago, when the internet was just getting started. We have far more growth drivers now.
Not only that, technology is playing a far larger role in our economy and society.
In our “always on, always connected” data-centric society, mobile technology and Big Data have emerged as unstoppable mega trends that’ll continue to drive underlying growth for years.
Reason #2: A More Rational IPO Market
Next time you see an article that says something like, “Tech IPOs Partying Like It’s 1999,” do me a favor…
Trash it immediately.
It’s nothing but unoriginal fluff. And inaccurate, too.
In the dot-com days, everybody won. Fundamentals, logic and any semblance of reason were cast aside. It was utterly absurd.
In 1999 alone, 480 IPOs launched. Of them, 308 were internet and tech-related companies.
But there was a dark side to the boom: Around 75% of those 308 had no earnings at all.
Yet 117 of them doubled – and sometimes tripled – in price on their very first day of trading.
In addition, consider that in the years leading up to the dot-com bubble, 80% of tech IPOs had only been in existence for four years, and generated less than $50 million in annual revenue. So for these firms, since they had such low revenue, going public was just a way to rack up some more operational capital.
If that doesn’t scream excess, I don’t know what does.
These companies had no business going public, and they needed massive amounts of borrowed capital just to stay alive.
But when the well ran dry, these companies – and the market – got smashed.
It’s an entirely different ballgame today.
For starters, tech IPOs are far more mature today. In 2013, the average tech IPO had been around for nine years and boasted revenue of $200 million or more.
And while the IPO market today is the best it’s been since 1999, it’s still extremely modest in comparison.
In 2013, 222 companies went public. But only 40 of them were tech companies. Why?
Because the venture capital industry is in recovery mode and there’s less funding available.
According to PricewaterhouseCoopers, venture capital funding hit $9.5 billion in Q1 2014, compared to the $40 billion that venture firms shelled out in Q1 2000 – right before the bubble burst.
The truth is, publicly traded tech firms have far more cash today than they did in the dot-com era.
In addition, there’s a much longer waiting period before IPOs launch. And while some stocks are still overvalued, investors are much warier now. If a company launches without a viable business model, sound numbers and growth catalysts, we’re not going to see the same kind of blind euphoria.
Reason #3: Anti-Bubble Policies
Another spark for the dot-com bomb? The Taxpayer Relief Act of 1997.
That’s according to Zhonglan Dai, Douglas Shackelford and Harold Zhang in their report – Capital Gains Taxes and Stock Return Volatility: Evidence From the Taxpayer Relief Act of 1997.
The Act lowered the maximum capital gains tax rate from 28% to 20% for investors who held assets for over 18 months. However, it left the higher dividend tax rate unchanged.
This gave investors a compelling incentive to buy more non-dividend-paying stocks. And they flocked to high-growth internet companies.
The authors concluded that increased volatility in these companies produced substantially higher returns. But a dangerous bubble was forming.
Then-U.S. Federal Reserve Chairman, Alan Greenspan, recognized the excitement in emerging internet companies. But since growth stocks tend to be valued on their potential future cash flow, the Fed (along with many others) anticipated future growth and didn’t raise interest rates for over a year. It feared higher rates would kill growth.
By 1999, an obvious and massive tech bubble had formed. The Fed finally reacted and raised rates – from 4.63% in January 1999 to 6.54% just six months later. But it was too late, and the bubble exploded.
Today, the situation has changed…
First, the Jobs and Growth Tax Relief Reconciliation Act of 2003 taxed dividend payouts as capital gains, not income, thus making all asset classes equally attractive.
And second, we have a very different monetary policy. Since 2009, interest rates have remained between zero and 0.25%. And new Fed Chairman, Janet Yellen, has reaffirmed the Fed’s commitment to a pro-growth environment, saying that interest rates won’t rise until the end of 2015.
Simply put: In 1997-1999, lower interest rates were detrimental, as investors had more money available to buy risky internet stocks on the expectation of high growth. The bubble was fueled and exploded when these companies failed and the sector collapsed.
But today, the tech market is very different, more diverse and more developed. Consistently lower rates help both companies and investors. They fuel tech growth and lessen the chance of a massive selloff. And when rates do rise, it will occur gradually.
You Can Still Invest… And You Can Still Profit
Bottom line: There’s no doubt that tech stocks have become frothy, with some companies trading at ridiculous valuations.
But is it comparable to 1999-2000?
Not in the slightest.
Back then, companies went bankrupt, investors lost millions and the Nasdaq shed 78% of its value, trading under 2,000 points for the next four years.
Today, the sector has matured and tech companies are now a far more critical part of the economy than they were 15 years ago.
Every bullish run needs to pause for breath before getting back on track. If tech stocks were rising without selling off, we’d have reason for alarm.
So the current selloff is not only necessary… it’s healthy.
And while some commentators are pushing the panic button, if you think you can’t still invest in tech stocks – and profit – think again.
In every selloff, great companies still exist. Strong, high-growth innovators creating the next breakthrough technologies, changing industries – and making profits for investors.
The current tech sector weakness offers a terrific opportunity to buy these companies for less.
But how do you identify the best ones?
Well, that’s the easy bit. Just follow my C.H.A.O.S. System, which I specifically designed to do just that! I’ll have the next candidate for you on Saturday, so stay tuned.
Your eyes in the Pipeline,