Tech Stocks: Brace for a Bursting Bubble?

Any potential downturn in the tech sector might cause pain for some investors, but it likely would pose little danger to the overall U.S. economy.

A recent article in Vanity Fair (of all places) seems to have troubled several in the financial community. Appearing in the September 1 issue and titled, "Is Silicon Valley in Another Bubble…and What Could Burst It?" its author, Nick Bilton, draws parallels to the tech bust of 2000. He and subsequent commentary suggest that a burst bubble now, as in that past episode, would impose huge losses on investors and precipitate an economic decline. Enough evidence of a social media bubble, if not one for the broad tech sector, exists to warrant attention, but when it comes to the economic ramifications, reality diverges from such fears on at least two levels: 1. a deflation of a social media bubble would not approach the scale of what happened in 2000, and 2. even the tech bust of 2000 had less economic impact than many suppose, certainly than the recent commentary suggests.1

Evidence, in Mr. Bilton's words, of "eerie familiarities to the infamous bubble of 1999" rests on five observations (excepting, of course, the proximity to Halloween):

1. The spending on buildings, parties, salaries for new graduates, and the like rivals what went on in the late 1990s as the last bubble inflated.
2. The Nasdaq Index2 recently surpassed its old highs of 2000.
3. The preponderance of tech startups, what the industry for some reason calls "unicorns," rivals what went on in 1999.
4. The Shiller price-to-earnings (P/E) multiple signals an overpriced market generally.
5. Ominously, at least in the eyes of those calling for a bust, money on balance is flowing out of tech companies and into the general market, even as the heavy flow of startups continues. Though not identified as a concern in Bilton's and other such discussions, one might add a sixth observation: The new companies in Silicon Valley are distinguishing themselves from their ancestors of 1999 by stating that they do not just want to get rich, they also want to "make the world a better place." They see this as a difference in kind, but in reality, such rhetoric screams that Silicon Valley has, if it were possible, reached even higher levels of self-important arrogance than it had 15 years ago.3

Some of these observations, though, do give pause. The endless flow of so-called unicorns, for instance, could signal froth, as might the lavish spending by such companies. One of these observations might actually suggest the opposite of a bubble. That several of these firms have pushed some of their value into other investments in the general market points to a diversification and, consequently, a source of stability that certainly did not exist in 1999–2000. Other of these observations are either meaningless or say little about the foreseeable future. In the former camp is the concern that the Nasdaq, after 15 years, finally surpassed its old highs. That is hardly an ugly sign, since earnings have long since done so. As for the Shiller multiple, it famously signals overpricing for long periods before the market actually peaks, sometimes years. When it becomes apparent after the fact that the market did peak, many in the media give the Shiller ratio credit for having given the first signal. Saying over a long period, sometimes years, that markets will eventually peak is, of course, a safe bet, though its use as an investment guide is dubious.

The Economy
If there is some reason to fret over a bubble in social media stocks, the economy is a different matter. Certainly tech, much less social media, is less of a factor than it was in 2000. Back then, all technology stocks had reached such high relative values that they constituted more than one-third of the entire S&P 500® Index.4 Their over valuation had raised P/E multiples (as measured in the conventional way, much less the Shiller method) to an unprecedented high of around 45 times the previous year's earnings. Today, this measure of overall market value stands just over 20 times the earnings of the previous four quarters, far less extreme than in 2000 and actually less extended than the measure has averaged for the past 35–40 years. Even if a bubble in social media stocks were to burst, it clearly would have less effect on financial markets in general than did the general tech bust of 2000 and certainly less on the economy.5

Even in 2000 the economic impact of the tech and general market collapse could hardly be described as severe. At the time, the interruption in growth caused a lot of consternation because it followed the impressive performance of the 1990s and because the terrorist attacks of September 11, 2001 threatened to prolong and deepen the economy's problems. But it hardly qualified as recession. The National Bureau of Economic Research, the arbiter of cyclical peaks and troughs, still indicates an economic peak in March 2001 and a trough in November that same year, an eight-month stretch. But the Department of Commerce’s latest reading shows more of a slowdown than a recessionary decline. After growing 4.1% in 2000, the country's real gross domestic product (GDP) slowed to 1.0% rate of growth in 2001 and a 1.8% in 2002. The worst quarter was the third quarter of 2001, in which real GDP fell at a 1.3% annual rate. Were it not for the terrorist attacks, 2002 no doubt would have seen a stronger recovery. Since even this historic tech bust of larger proportions than the one threatened today prompted only a mild economic setback, and that was reinforced by terrorist attacks, the prospect of frightening economic trouble from this source today seems slight indeed.6

Should the Vanity Fair-threatened bust occur, a lot of people will lose a lot of money. But the economic effects will almost surely remain contained. Certainly, the comparison to 2000 powerfully supports this contention. Further, it is worth considering that social media, even with its fantastic growth of recent years, still constitutes only 1.4% of the country's GDP. The entire Internet is still only about 3.4% of the economy. And though much else relies on the Internet in general, and social media in particular, the services will continue even if the stocks were to lose much of their value, even if some of these now high-flying firms were to go out of business. And as in 2000, the stake is about equities not debt, so even in the unlikely event of widespread bankruptcies, the shock would have a limited echo in the rest of the financial system.7

1Nick Bilton, “Is Silicon Valley in Another Bubble…and What Could Burst It?" Vanity Fair, September 1, 2015.
2The NASDAQ Composite Index measures all NASDAQ domestic and non-U.S. based common stocks listed on The NASDAQ Stock Market. The Index is market value weighted, meaning that each company's security affects the Index in proportion to its market value.
3Bilton, op. cit.
4The S&P 500® Index is widely regarded as the standard for measuring large cap U.S. stock market performance and includes a representative sample of leading companies in leading industries.
5Data from Standard & Poor’s.
6Data from the National Bureau of Economic Research and the Department of Commerce.
7See, James Manyika and Charles Roxburgh, “The Great Transformer: The Impact of the Internet on Economic Growth and Prosperity,” McKinsey Global Institute, October 2011.

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