The pandemic bubble has popped after unsustainable growth in sales and stock prices, but investors will want to choose wisely moving forward instead of jumping into index funds or ETFs
Companies with big dreams and sometimes life-changing ideas, speculative young companies going public, and an industry weighing on the S&P 500 index: It was a recipe for a big run-up and a big fall.
That description can apply to elements of the current tech wreck as well as the dot-com bust of 2000-2001. A major warning sign for each downturn was how heavily the tech sector was weighted in the S&P 500 index. But there are also some big differences between that speculative internet era and today, when now-established companies saw massive growth spikes during the pandemic before a slowdown as the overall economy sputters for a variety of reasons.
More than six years ago, MarketWatch explained how the rise in tech stocks was different from the dot-com boom, due to the coinciding growth in mobile devices and apps and cloud computing, but the past two years of unsustainable pandemic-fueled gains and an investing flurry changed that dynamic. The sharp downfall of tech stocks through the first five months of this year has wiped away those gains.
“In the aggregate, then as now, the numbers didn’t make sense,” said Lise Buyer, founder of Class V Group, which helps companies go public. “For the last two years valuations haven’t made any sense, people have speculated and won, but no one should think it was investing at those values…Markets are cyclical, neither extreme lasts very long.”
The big question for investors is what happens next, as declining tech stocks keep pushing overall markets closer to official bear-market territory. The answer may be that tech will not move as one overall group. Different sectors and specific companies will react differently after years of growth were piled into the first two years of the COVID-19 pandemic. Some market mavens believe investors need to choose wisely if they decide to wade into these stocks at these depressed prices.
Brendan Connaughton, founder and managing partner of Catalyst Partners, is not worried about the future of tech, but he advises investors to look at individual stocks and their fundamentals, instead of index funds and ETF investing right now.
Tech revenue growth had still been outpacing the growth rate of the S&P 500 as a sector, he said. “Of course, you are going to slow down because so many were pandemic beneficiaries. You go from 50% [revenue] growth to 20%. That still beats the pants off what you are getting in the S&P overall.” He said this is not a market he wants to buy through an ETF. “I would rather take advantage of this downdraft and buy really great companies.”
Connaughton gave a prescient warning to investors last year in this column, noting that tech stocks were getting close to a dangerous level.
“In the dot-com era, tech was over 30% of the S&P and we saw it blow up,” Connaughton told MarketWatch last July. ”At some point things get too weighted and they unwind themselves. Anytime a sector gets 30%, something bad happens and it goes back down.” He pointed out that the industrial companies suffered from this in the 1930s and the energy and oil business was the biggest sector in the S&P 500 in the 1970s.
By the end of last year, the information-technology sector was approaching that limit, weighted at 29.5% of the S&P 500 in December, and that IT sector does not even include some of the biggest names in tech, such as Alphabet Inc. GOOG GOOGL, Facebook Inc. parent Meta Platforms Inc. FB, Amazon.com Inc. AMZN and Netflix Inc. NFLX, which are placed in different categories such as communications/interactive media services and consumer discretionary.
Just after the new year, the Dow Jones Industrial Average DJIA reached an all-time high of approximately 36,799, but is now off about 9.46% this year, while the S&P 500 SPX has seen a slightly steeper drop. At one point it was down 17% year to date, from its January high of around 4,796, but as of Friday it’s off 13.8% in 2022. The tech-laden Nasdaq COMP is down 23.22% year to date, after falling as much as 28% lower. Since hitting its all-time high of 15,971 in early November 2021, the Nasdaq is off 24.78%.
Those numbers, though, pale in comparison to the market correction following the dot-com boom. The Nasdaq fell nearly 40% in that market implosion, after reaching a peak in March 2000 of 5,048, arguably the last massive technology-fueled stock-market correction. At that time, there were four tech companies in the Dow Jones Industrial Average: Hewlett-Packard Corp. HPQ HPE, IBM Corp. IBM, Intel Corp. INTC and Microsoft Corp. MSFT. But tech, along with communications, was the heaviest-weighted sector in the S&P 500.
While a heavily tech-weighted S&P 500 was a warning sign for investors, one of the biggest differences between now and the dot-com bubble of 22 years ago was that that nascent era of the internet was driven by speculation in companies that jumped on the bandwagon early with buzzwords about eyeballs and daily user metrics, but some did not have revenue, earnings or in rare cases, even an actual product.
“That was about separating real companies from impressive slide decks,” Buyer said. “Back then, a lot of those companies were never companies to start with, they were investments based on FOMO, even though we didn’t use that phrase at the time.”
The internet IPO craze was launched with the offering of Netscape Communications Corp., the first user-friendly web browser that opened up the World Wide Web to regular consumers. The company’s successful IPO 16 months after it was founded helped ignite the internet gold rush, during which many companies took advantage of what became a huge public obsession with the emerging technology. Out of the many startups that failed — like Webvan, Pets.com, and eToys.com, some of which were ahead of their time — came some of today’s still-extant tech stalwarts, like Amazon, eBay Inc. EBAY, and Nvidia Corp. NVDA.
Amazon and Netscape were “good-quality IPOs when they went public,” said Dan Morgan, a senior portfolio manager at Synovus Trust ”But in the late ’90s it deteriorated to more speculative companies going public.” He noted that phenomenon also occurred in the past couple of years. This time around, the risky trends in 2020 and 2021 were the SPAC blank-check companies and the many China-based companies that went public at very high valuations in 2018 and 2019.
Most of the contributing factors currently being blamed for the overall market’s general downturn are different from when the internet bubble of 2000 popped. Today the overriding issues are inflation, stagflation, higher interest rates, higher oil and energy costs, supply-chain issues, the war in Ukraine, and now growing fears of recession, as brought up by Snap Inc. SNAP in its recent regulatory filing, which took the wind out of one attempt at a market recoverythis week.
Indeed, now the continuing meltdown in stock prices is boosting the risk that a recession arrives sooner than forecasters have anticipated. On Thursday, software behemoth Microsoft slightly cut its guidance due to the stronger dollar, which usually leads to revenue hits for companies with large operations outside the U.S.
Savvy investors today need to look at the fundamentals of companies, working cash flow, dividends and, of course, profit levels, which have been abnormally high during the past two years. Many companies are beginning to constrict their spending, and/or initiate some small rounds of layoffs, such as Netflix Inc. NFLX,Uber Technologies Inc. UBER and PayPal Holdings Inc. PYPL.
“There will be layoffs, and some companies will go away,” Buyer said. ”I am not predicting that these companies go back to those higher levels, but if they mend their profligate ways, those that can tighten their belts, will come out of this stronger.”
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