Those who do not wish to draw any parallels between today’s stock market and the 1999-2000 tech stock bubble typically claim that “All of those turn-of-the-century dot-coms weren’t making any money. Today’s 2017 superstars — Facebook (FB), Amazon (AMZN), Netflix (NFLX) and Google/Alphabet (GOOG) — make money hand over fist!”
The problem with this rationalization is threefold. First, the 1999-2000 tech balloon was not an online-only phenomenon. The ‘Four Horsemen’ that controlled more than half of the market capitalization for the ill-fated Nasdaq — Microsoft (MSFT), Intel (INTC), Cisco (CSCO) and Dell — were exceptionally profitable. They were also extremely overvalued at a combined price-to-earnings ratio (P/E) of 60. It follows that the notion that Facebook (FB), Amazon (AMZN), Netflix (NFLX) and Google/Alphabet (GOOG) represent something entirely different in terms of profitability is flawed, especially when one considers an average P/E of 130 for ‘FANG.’
Second, the ratio of American households’ net worth to disposable income in 2000 hit 620% due primarily to an eighteen year secular bull market and tech stock euphoria. It was unsustainable, however, largely because the ratio had rarely deviated more than 1 standard deviation from its mean and because asset prices had frequently correlated with after-tax wage growth. Similarly, the ratio hit 650% on residential housing jubilation prior to the financial collapse in 2008. That too was unsustainable. Now we have ‘FANG’ stocks emulating the ‘Four Horsemen,’ the median stock bubbling over with froth, and real estate prices in key parts of the country stretching affordability. Should investors really be dismissive of the 670% ratio in 2017?
Third, one of the more prominent reasons for the tech implosion in 2000 had been the effect of margin debt. Many investors had been betting the proverbial farm on a “New Economy” paradigm, leveraging their stake in the tech revolution by purchasing stock on margin. Gains were amazing on the way up. However, once the tide turned, ‘margin calls’ unleashed the forced selling of the very same companies to replenish margin account reserves. In other words, the greater the leverage on the most popular stocks, the greater the downside destruction… no matter how profitable the companies.
