Dot-com bubble 2.0?

The tech bubble burst 20 years ago, with investors losing huge sums. Today, tech stocks have high valuations again. Is a new bubble forming? What are the parallels with the situation back then and what are the differences?

An article by Benjardin Gärtner,

Head of Equity Portfolio Management

In summary

  • The dot-com bubble was created by investors’ overly optimistic expectations and valuations that were not based on fundamentals.

  • By contrast, the current rise of tech stocks reflects the strong growth of these firms’ core operations.

  • Although valuations are already high, software and platform companies still have potential for growth and thus for higher share Prices.

  • However, a high proportion of market capitalisation in the S&P 500 index is attributable to tech stocks, creating new risks for Investors.

Are we in a new tech bubble, a dot-com bubble 2.0? Although the meteoric rise of shares in internet firms such as Alphabet and Amazon may appear to be a lot of hot air, their valuations are anything but castles in the air. These companies are benefiting from network effects and expanding markets, so their cash flows and profits are shooting up. And they remain extremely attractive to investors in the current macroeconomic climate of slow growth, falling productivity, low interest rates and demographic change.

Inflated expectations

But let us cast our minds back. The dot-com bubble began when internet browser provider Netscape joined the tech-focused Nasdaq stock exchange on 9 August 1995. This loss-making company, which had only been founded in 1994, made its stock market debut at US$ 28 per share. During the first day of trading, the share price hit almost US$ 75 at times. Anything internet related that had ‘.com’ or ‘e-’ in its name went down a storm with investors from the mid-1990s onwards, regardless of whether there was a robust business model behind it or not. Investors became greedy when faced with the prospect of making huge gains from the seemingly endless world wide web.

These inflated expectations reached their peak at the start of 2000. The Nasdaq Composite index had grown fivefold in five years. Traditional KPIs, such as price-to-book ratio and price/earnings ratio, were declared irrelevant. Companies’ valuations did not match their fundamentals.

Phase of disillusionment

When the tech bubble finally burst in March 2000, trillions of dollars of market value went up in smoke. In this phase of disillusionment, the Nasdaq fell by almost 80 per cent and closed at 1,114.11 points on 9 October 2002. The downward spiral of share prices was triggered by interest-rate increases by the Federal Reserve and the cooling of an overheated US economy. Lenders and investors became more risk averse, and there was a return to more realistic valuations. However, the economic fallout was less dramatic than after the 2007/2008 financial crisis. The US economy avoided recession, and there was no banking or financial crisis.

Current parallels with the tech bubble?

The situation today cannot be compared with the excesses of the dot-com era. Although a number of companies making significant losses have recently come onto the stock markets, especially in the US, the euphoria is being kept in check. The markets are making a distinction between companies with business models focused on strong growth and profitability and those shares that are built merely on hopes and hot air.

The current rally of tech stocks is not a bubble that is about to burst.

Benjardin Gärtner

The current rally of tech stocks is not a bubble that is about to burst. The high valuations are realistic, provided that the companies continue to generate growth in the market. That is why it is important to keep a close eye on their performance and take action if necessary.

The number of listed companies generating strong growth is limited. Apple’s market capitalisation alone is roughly the same as the market value of all 30 DAX firms together. This is partly due to its high profitability and healthy growth prospects. In an environment of falling productivity, slow growth rates and demographic change, companies with these credentials look particularly appealing compared to other investments, such as bonds.

Impenetrable market

Many of these companies can rely on genuine network effects, including consumer-oriented online giants Amazon and Facebook and payment service providers such as Visa. They boast strong global brands and platforms and have sufficient finances to allow them to expand their market position, making it very hard for other firms to compete with them. Moreover, software and platform companies have potential for further growth, for example due to the increasing prevalence of cloud computing.

The market leaders in cloud computing are Amazon with its Amazon Web Services (AWS) and Microsoft with Azure. Alphabet, Google’s parent company, has also ventured into the cloud market with its Google Cloud Platform (GCP) and is now ranked third. So it seems that the established players have captured most of this new market between them.

The situation is similar in the field of big data, i.e. the analysis of huge volumes of data, which is becoming increasingly mobile and used in industrial settings. It offers the prospect of even greater revenue and profit. Here too, it is the internet giants that are making the most of the opportunities presented by data analysis, whereas SAP and other software vendors tend to supply the necessary ‘tools’. Nonetheless, there is still some space for younger software companies, such as and Splunk.

Technology: new vs. old economy

Indexed performance since 1 January 1995
Technology: new vs. old economy
Source: Bloomberg; as at: 20 January 2020.

Safe haven

Against a backdrop of tensions caused by the trade dispute between the US and China, US software stocks have proved extremely robust. The US leads the way in this sector. Because European internet giants are few and far between, European tech stocks account for a relatively low proportion of market capitalisation.

For many investors, companies such as Microsoft and SAP have therefore become a kind of ‘safe haven’. Apple, Amazon and Alphabet also have impressive market capitalisation underpinned by solid and expanding profit streams. The shift from one-off licences to regularly recurring subscription and service revenue is resulting in predictable cash flows. This creates a feeling of safety for investors, a rare commodity in today’s world.

The shares of these platform and software companies have become a new kind of ‘nifty fifty’. The term ‘nifty fifty’ described 50 dinosaurs of the old economy that caused a stir in the late 1960s with their reliable profits and thus high market valuations. They outperformed the broader market for years on end. Google, Amazon and Microsoft can be seen as modern-day ‘nifty-fifty’ equivalents as they are also thriving in an environment of slow real growth rates, low real interest rates and heightened geopolitical uncertainties. In these times, predictable revenue streams are worth a great deal.

Background: new risks

The rise of tech stocks over the past ten years has had a positive impact on the market as a whole. In the US, just ten stocks are responsible for almost a third of the S&P 500’s climb since 1 January 2010: Apple, Alphabet, Amazon, Facebook, JPMorgan Chase, Johnson & Johnson, Home Depot, Mastercard, Microsoft and Visa. The picture is similar in Asia.

If these profitable firms were to disappear, the indices in which they are included would face a substantial downside risk, as would the investors who track the indices. It is still not clear what risks to market stability are posed by this concentration. Depending on the sector in which a company operates, there may be genuine risks, for example due to tighter regulation, reduced market access or disrupted supply chains.

Just ten stocks are responsible for 30 per cent of the S&P 500's climb

Contribution to the rise of the S&P 500 since 1 January 2010; Index points of the S&P 500
Just ten stocks are responsible for 30 per cent of the S&P 500's climb
Sources: Bloomberg, Union Investment, as at 20 January 2020. * Alphabet, JPMorgan Chase, Facebook, Visa, Johnson & Johnson, Home Depot, Mastercard. ** From index climbers and fallers in the stated period 770 shares.


As at 18 January 2020