“But this time it’s different” they said...
The late 90s was a time of contradiction.
We were all beside ourselves with excitement about the world-changing potential of the internet.
We were all beside ourselves with worry that the Y2K millennium bug would break the world as we knew it.
Both of these feelings co-existed in the public consciousness, creating a palpable sense of being on the verge of something new and exciting, for good or for ill. And while the Millennium Bug turned into the most anticipated non-event ever, with digital time-keepers having no problem ticking from 11:59 on the 31st December 1999 to 00:00 on 1st January 2000, there was trouble brewing elsewhere...
At the time, the internet was something fresh, full of possibilities and promises. This was the so-called new economy: internet-enabled businesses were going to change how we work, learn and play. And this has come to pass — most of the things we take for granted now were conceived at the turn of the century.
Believe it or not, the very concept of Silicon Valley was unknown to most of us before this time. Suddenly it was on everyone’s lips: Ivy League graduates flocked to San Francisco’s Bay Area to start tech companies and make their fortune. Geeks — and their movement to reclaim the word — were going to take over the world! There was a sense that the dinosaurs running the incumbents would become obsolete, and the new internet economy would topple old kings.
And the way these companies got investment was changing. Gone were the days of business models, margins and revenues. The only number venture capitalists cared about was views of your site. And the way you got these?
This created an infinite loop — VCs poured money into companies that were advertising, this was spent on more advertising, more people saw these sites, more money was invested and then spent on advertising. Some start-ups were spending up to 90% of their investment in this way. Eventually, an Initial Public Offering (IPO) would happen, with the public buying shares in these highly valued companies. And so, the bubble inflated.
In 1999 alone, shares in chip manufacturer Qualcomm rose 2,619%, alongside 21 other large-cap stocks which rose 900% or more. Qualcomm reached a Price to Earnings ratio of 200.
You might remember we previously wrote about the 1929 S&P stocks’ Price to Earnings ratio reaching 32.6, which, at the time, was regarded as an indication of abnormally high valuations for companies not yet making a profit. Qualcomm’s Price to Earnings ratio of 200 is indicative of just how much investment technology companies were receiving without investors expecting the company to prove a profit.
Between 1995 and 2000, the Nasdaq index rose 400%. The Nasdaq Composite — nowadays Nasdaq 100 — was (and is) more focused on technology than the S&P or Dow Jones, so was the best barometer of the bubble. That's evidenced in the fact that, during 1999, the Nasdaq Composite rose 85.6% while the S&P 500 Index only rose 19.5%.
In fact, overall more stocks fell in value than rose, but this was because investors were selling their stocks in non-internet companies in favour of buying internet-flavoured stocks.
And so, the merry-go-round kept going round, until it didn’t.
With the Millennium bug nothing but a distant memory, March and April saw the market overheating, before beginning its descent. But unlike the spectacular two day 23% loss of 1929, this was more like the air slowly being let out of a balloon, leaving just a small sad piece of rubber where the excitement of a dot-com revolution had once been.
On March 10, the Nasdaq Composite hit a peak of 5132.52, which was 390% higher than four years previously.
By the end of that year, cracks were starting to show, with a 52% drop from that March high.
Come October 9th 2002, the Nasdaq Composite closed at 1114.14, representing a 78% loss from its 2000 peak.
Trust in dot-com companies had eroded, with the media and then the public questioning whether these e-businesses could justify their sky high valuations. This was exacerbated by the Fed raising interest rates, making borrowing less attractive.
Pets.com has the dubious honour of being the poster child for the dot-com crash. A business built around shipping supplies to pet owners, it initially raised $82.5 million through an IPO in February 2000, with shares trading at $11 each. These briefly climbed to $14, but between January and September the company lost $147 million. In November, shares had dropped to below $1, and the business closed forever.
A wild eleven months for a company that traded primarily in kitty litter.
This is just one example of the crash though, and for many investors, it was more drawn out, making its descent over several years. It was possibly the sell order of many high-tech companies like Dell and Cisco in the spring of 2000 that initially made investors nervous, leading to a lot of frantic sales and leading to the market losing 10% of its value. However, at the time, this was seen by many as merely a market correction.
Ultimately, though, this had a knock-on effect on the amount of investment capital available to dot-com businesses, which until then, had been on an advertising spending spree with no regard for creating a sustainable business. Within months, lacking the lifeblood of a growing business — cold hard cash — many of these businesses went bust.
The merry-go-round had come to a juddering halt.
As we said at the beginning, these internet businesses were fundamentally correct in their assumption that we’d all eventually do our shopping, run our lives and get our entertainment online. So what did they get wrong?
The world — or the technology used by the world — just wasn’t ready for the transformation. Most of us still used landlines at home. Mobile phones were only just starting to become commonplace, and network speeds and bandwidth was appalling and signal patchy.
There was also a lack of trust regarding making online payments. Very few people were happy to use their credit card online. That isn’t surprising, given the amount of effort banks and credit card companies were putting into warning people about the dangers of the internet.
These lessons apply to investing at every level, during every stage of a bear market and every stage of a bull market. The key considerations are always timing, fundamentals, and trust.
The internet-enabled businesses of today enjoy a different environment: the infrastructure and products exist for widespread adoption, companies providing these have (mostly) sustainable business models, and the public trusts these services and companies. Only with these in place did the world become ready for the take-off of internet-enabled businesses.
Of course, there are big names that survived the dot-com crash, including eBay, Amazon and Priceline, who have perhaps become so ubiquitous thanks to the baptism of fire they experienced at the very beginning.
It would take 15 years for the Nasdaq to regain its dot-com peak.
But before then, there was another bump in the road, in the form of 2008’s housing crash and many more other lessons to learn.