Partying like it is 1999
My son has just turned 21 but he did not have much of a party as he was locked down in a university room. The market, on the other hand, has been partying hard of late and seems to be looking back to December 1999. Current market conditions reminder old-timers like myself of the dot-com and TMT boom of the time. There are a lot of parallels in the market between December 1999 and today.
Last week, two Initial Public offerings in the USA – for DoorDash and AirBnB – saw huge gains for those few investors lucky enough to get an allocation of stock. At the time writing, a few investors are sitting on profits of 78% and 115% respectively after just one day of trading. The founders are now newly minted billionaires and early, pre-IPO investors have made hundreds of millions of dollars. In 1999 there were similar IPOs and huge spectacular gains by those few investors in companies in the so – called “New Economy” Sectors – Technology, Media and Telecom(TMT) – who were lucky enough to get stock.
Just having a website and an internet strategy was enough to get a company listed. Very few people today remember stocks such as Webvan, Pets.com, Worldcom, Global Crossing, Enron and hundreds of others which were absurdly popular but have since disappeared along with billions of dollars of shareholders’ capital. Many of these companies had no profits, had huge capital expenditure plans, and promised investors they would be the kings of the so called “New Economy”.
Investment analysts suggested that as some of the new internet retail companies have little or no sales, they should be valued based on the number of “clicks” their websites had. An article I read at the time noted this would be like valuing Walmart, Sears or Marks & Spencer on the number of people walking into the shop irrespective of whether they bought anything!
Today in 2020 we see many high-flying companies in Technology, Electric Vehicles, E-commerce etc. – many of them have no profits to show and have negative free cash flows and trade at multiples of more than 30 times current sales.
In 1999, market gains were driven by a new generation of investors who were able to trade stocks using desktop computers for the first time. Today, the boom is driven by 20 something investors trading in fractional shares with zero commissions on their mobile phones on platforms such as Robinhood and Webull.
The new investors of 2020 have made spectacular fortunes rapidly and come to believe they are market geniuses. In 1999, there were many articles and comments that Warren Buffet, who has one of the most successful long-term investing records, had lost his touch and was too old to understand the New Economy. In the UK, the late Tony Dye, a Fund Manager at UBS who had been a long-term value investor was widely criticised for his under performance and resigned in February 2000. The subsequent market crash vindicated him, but he was out of the market.
In 2020, many long-standing value investors in the USA have given up managing money after a few years of underperformance. There are numerous articles and comments to the effect that value investing does not work and, at least by implication, that valuations do not matter. This can very easily morph into a dangerous investment practice- buy at any price.
In 1999 Investors believed that any declines in the market would prove to be a buying opportunity as investors believed in the Greenspan Put which was named after the then leader of the Federal Reserve Board. Any falls in the market would be temporary as Greenspan’s Fed would cut interest rates. In 2020, the interest rates and bond yields are already near zero and there is little room for more cuts. Now markets are hoping the Fed will push Bond yields below zero by increasing its bond buying programme and a fiscal boost through even more deficit financing. Perhaps these will be called the Powell and Yellen .
Puts after the Chairman of the Fed, Jerome Powell and his predecessor Janet Yellen who is the Treasury Secretary in the new Biden administration.
Markets in 2000 were driven by the powerful assumption that the internet would change the world and investors in TMT stocks would make lots of money. The first assumption was true but the second one was mostly wrong. The internet has indeed changed the world though it has taken much longer than those optimistic investors in 2000 thought. Some technology companies have proved to be spectacular investments but many more have not. In the world of futurology, it is often easy to get the big long-term picture right but very hard both to forecast how the dynamics of competition will pan out and pick the winners. Technological advances often provide great long-term benefits to consumers but frequently serve up severe pain for investors.
The frothy markets gave rise to absurd valuations, new high technology companies were at market capitalisations many times higher than existing profitable companies which had been around for decades. Today, the market capitalisation of Tesla is more than half a dozen rivals combined. Tesla is on track to sell to sell 440,000 cars in 2020 compared with 20mn cars for its rivals. That is not to say Tesla is not a great company or that it does not have good product, but its valuation just seems to be greatly overstretched. The current price assumes a lot of flawless execution, profitable growth on the part of Tesla and a great deal of inaction from their rivals. None of these factors can be assumed.
December 1999 was by no means the high point of the market. The Nasdaq 100 doubled in value in the first three months of 2000 with many stocks showing unbelievable advances. The market peaked in the last week of March 2000. It then fell 82%in the next two and half years. Billions of dollars of capital were wiped out especially in the TMT sector. The crash laid bare the flawed business models of many of the companies which had been hyped up in the ascent of the market. Many went bankrupt and large frauds were revealed at companies such as Worldcom and Enron. As Warren Buffet has noted “it is only when the tide goes out that you see those who have been swimming naked.” The scale of value destruction in the 2000 to 2003 bear market was immense.
There are many other strong parallels between the market situation today and that which prevailed 21 years ago in December 1991. However, history does not always repeat itself, but it often rhymes. Nobody can say whether the market will double in the next three months before giving way to a brutal two and a half year bear market.
We do not believe we can forecast markets with any reliability or consistency and are sceptical of those who claim to do so. All we can do is look at history and note the parallels. The historical evidence suggest that markets do fall every ten or so years. The 1991 Savings & Loan debacle led to sharp market declines and the 2008-2009 global financial crisis saw a scale of capital destruction that exceeded that of the TMT collapse of 2000-2002.
Large advances in the market leads to a new generation of market investors who come to believe they are market geniuses. Reading about huge one-day IPO gains leads people to believe that markets can only go up and that making quick money is effortless and inevitable. These beliefs are particularly strong among younger people who have a poor memory of the last crash and no experience of losing capital at the time. Nothing can cure people of these notions as effectively as a periodic sharp bear market. That is the reason Mr. Market serves one up every eight to ten years. Huge value destruction inevitably occurs.
We would recommend market participants to be more careful at this juncture. Traders should use trailing stop losses. Investors should re-examine the business models and valuations of companies they already own.
If companies are unprofitable and not generating positive free cash flow and trading on very high multiples of sales, they should be looked at more carefully and considered for partial or complete disposal.
Good quality companies are rare and should be held for long periods if high-long term returns are going to be achieved. However, if these companies have also got very overvalued, investors should watch them carefully and perhaps sell some part of the positions held in the event of further advances.