Are We on The Verge of Another Dot-Com Bubble?

Dot Com Bubble

The dot.com bubble bursting in 2000 is legendary, where investors in their exuberance drove up prices to the sky, then the sky fell. Comparisons are now being made to today.

Richard Bernstein wasn’t just around to experience what is known as the dot.com bubble bursting in 2000, he actually called it. This actually did not involve any great leap of insight, as it was common knowledge that these stocks were wildly overbought, it was more like people getting on the train and staying on it while both prices and their capital gains kept zooming forward. This had to end and we knew it would be ugly.

Bernstein, who has had a successful career on Wall Street for 35 years, as the longtime Chief Investment Strategist at Merrill Lynch, and since 2009, as the CEO of Richard Bernstein Advisors, isn’t the sort to worry too much about bears under the bed normally, but does notice them when they come out and start making noise.

He is once again concerned about the technology sector, and given that this sector is pretty volatile, and the market itself may be ripe for a bear market soon, there would certainly be more risk involved in holding stocks like this, or the Nasdaq itself for that matter.

The Nasdaq famously lost 80% of its value during the 2000 crash, in a pretty violent manner as well, but this took us well beyond stocks just being more volatile than the average, as they are nowhere near that more volatile normally.

This therefore isn’t about the risk of tech stocks taking a hit, and probably a bigger one than the market as a whole, takes when this long bull market ends, which it will end someday. We’re talking about something a lot bigger when we make comparisons with 2000’s crash of tech stocks.

Bernstein Sees Comparisons to the Dot-Com Bubble

Bernstein observes that “we are at a point in the technology cycle where investors are starting to become pure momentum investors. You have this notion where people believe that tech is no longer cyclical. It’s something new. It’s something different. And, it’s sounding a bit like March 2000.”

At least he said only a bit, and we don’t want to take from this that he believes something of this magnitude will happen again, but he does see a significant meltdown in this sector, one that will make tech stocks really stand out again.

He is right in remarking that some people are seeing tech stocks as being at least less cyclical, especially if you weed out companies that aren’t really tech stocks like Amazon. Even so, this is difficult to imagine to be true generally, as spending on tech is generally pretty discretionary, and for instance, Apple sure feels it when their markets contract due to cyclical changes.

It doesn’t make a lot of sense to try to lump these stocks together too much, as there are many who really aren’t that dependent upon cycles, Facebook for instance. People will undoubtably use their apps come thick or thin, and when they are taken away for even a brief time, like we saw when they went down for a while on Wednesday, this becomes a major worldwide event.

It’s not that Facebook is immune from cyclical downturns though, as while these apps are free to use, their revenue would suffer somewhat, but perhaps not to the extent as some other companies would suffer. The world will still go around, and much of it will still revolve around companies like Facebook and Google as it does now. There is nothing that isn’t cyclical to some degree, but some are just less exposed than others, and some are more exposed.

This all therefore depends on the nature of a company’s business, and some businesses are more cyclical than others, but most are pretty cyclical, seeing their demand wax and wane depending on the level of economic prosperity present at any given point in time.

We’re seeing these economic conditions deteriorate lately, so investors should at least be wary of a potential dive, especially if clouds that we don’t really want to see start forming on the horizon. Bernstein is seeing these ominous clouds form now, but like the weather, we do get to see these storms approach and especially know when they are here.

It’s All About Being Ready When the Time Comes

Investing heavily in tech companies during the latter half of the 1990’s wasn’t necessarily a bad idea, and was a very good one provided that you didn’t stick around to take too much of a blow. Some did, and got punished, while many others just took their profits and waited for the storm to blow over before looking to get back in these stocks.

What spurred the fear that led to the meltdown in 2000 was the very high price to earnings ratios that manifested with a lot of tech companies, where the future was valued by investors at a lot higher level than was realistic. Bernstein does not see this as the problem these days, as these ratios are much more in line this time, but he feels that investors are still confused about how to treat earnings expectations.

In any upward movement, there is a component that of it that can be justified by fundamental analysis, and another component that is a result of pure momentum. In a sense, it’s all momentum, but the kind that Bernstein calls momentum is the part that isn’t backed up by business results.

Today’s market is being pushed up more by this sort of momentum than things like improving earnings growth, and he is right in believing that this component is riper for a downturn when one comes, when this momentum reverses. The floor in this case will be set a lot by the fundamentals, where prices go down to where investors start seeing more value based upon business circumstances, and the further we are to this floor, the more we may come down.

When earnings growth goes down and prices go up, like we’re seeing over the past few months, that is indeed something to be concerned about. When these concerns do manifest themselves on stock charts though, it does make sense to be more wary of a class of stocks that are known to be bought more on momentum and therefore have further to fall potentially, like tech stocks do.

It’s hard to argue against Richard Bernstein’s view here, and although the scale of such a decline may not be of the magnitude that he is thinking right now, if you don’t want to get wet, it shouldn’t matter how hard it is raining, just that it is.

The rain is not here yet, but it does appear to be on the horizon, and while it may not be quite time to go inside, it is wise to start preparing for the need to, sooner rather than later.