Are we facing another dot-com bubble?
- Marcus Brookes
- 16 July 2020
- 5 mins reading time
A good deal has happened since my previous blog, “Is now a good time to invest?” So I thought I’d take this opportunity to look at how share prices have performed since then, and what we can infer.
The first consideration has to be the virus itself, for which the news remains sombre. At the time of writing, there have been over 13 million confirmed cases and approaching 600,000 deaths worldwide according to Worldometers.info. The US continues to have the highest number of cases, with hotspots of resurgence demonstrating the need to sustain social distancing measures.
Despite the economic fall-out from the lockdown, we’ve seen share prices stage substantial recoveries in recent weeks. While this might seem welcome at first, a more in-depth view reveals reasons to question the sustainability of these rises.
Lopsided stock price rises
Firstly, the rises have been dominated by the small group of US technology giants that includes Apple, Facebook, Amazon, Netflix and Alphabet (Google). They’ve benefited from investor enthusiasm as customers increase their consumption of online services.
This has pushed the technology heavy Nasdaq Composite Index up to record highs in recent weeks. The concern being that the overall index gains are largely down to investor expectations for a relatively small number of companies.
Secondly, some observers are suggesting that there are echoes of the dot.com bubble that burst in the year 2000. In short, what happened then was over-optimism relating to the future profits that investors hoped technology companies would go on to generate.
This investor exuberance attracted money from more and more investors until reality struck and stock prices collapsed.
Back then, the ratio between the price of technology shares and the profits that one of those shares was entitled to reached 176, according to data from Bloomberg and Zacks Investment Research. In other words, if a company share accounted for $1 of annual profits, you would have had to pay $176 for that one share.
Since then, this ratio traded closer to the more “normal” level of between 15 and 20. That is, until this year. The ratio breached 23 in February, plummeted towards 16 in March and is now trading back up at around 22.
This is significant because it’s indicative of how hard it is to know the fair price for a company share at the moment. As I’ve mentioned before in articles and presentations, I anticipate a fairly sharp recovery over the coming six- to 18-months. But there will be some companies that won’t survive, and I don’t expect the recovery to be smooth.
To begin with, we don’t yet have a proven treatment for Covid-19. Even after the treatment is developed it will need to be distributed and administered, which will take months. During the interim, more financial stimulus will be required from governments and central banks.
All the while, we have to hope that politicians in the US, China, Brussels and London conduct themselves in such a way that reassures investors.
In the meantime, I continue to foresee a turbulent financial environment in which share prices continue to rise and fall sharply as hopes of economic recovery vie with a range of potentially destabilising factors.
That said, I’m not yet convinced that we’re facing another dot.com bubble. For starters, the companies whose share prices have risen this time around are few in number and hold massive market share in their respective fields. By contrast, 20 years ago, silly money was being paid for shares in companies that were struggling to establish sales, never mind make profits.
What of the individual investor?
In recent webinars, such as the one addressing income investing, guest speakers have consistently stated their belief that staying invested and ignoring the market noise is among the most sensible of investment strategies. I’m strongly inclined to agree.
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