TECH stocks set to lead new Decade after Nasdaq posted a 570% gain between 1995 -2000. Now a full decade later its down -50% from 2000 high.
Techs reflect on decade since dotcom boom
By John Authers and Michael Mackenzie in New York
Published: March 9 2010 17:47 | Last updated: March 9 2010 20:37
In January 2000, 17 dotcom companies paid more than $2m each to advertise during the Super Bowl, the season-ending national championship game for American football.
For anyone looking for the symbolic moment when an investment bubble led to excesses that were plainly unsustainable, that was it. Just a few weeks later, on March 10 2000, the barometer of dotcom mania – or what was the technology and telecom bull market of the 1990s – the Nasdaq Composite, closed at a high of 5,048.62.
That completed the Nasdaq’s stunning rise from a level of just 750 at the start of 1995, a gain of 570 per cent. Once it started to crash, it did not stop until it hit 1,114.11 in October 2002 – a drop of almost 80 per cent from its peak. Even on Tuesday, almost 10 years to the day since its high, the Nasdaq sits at 2,349, some 54 per cent from its greatest moment.
This was a bubble as insane as any in history. “It was a time when the rules of investing made no sense and as much as people liked to think things had changed with all the talk of a new industrial revolution, it was shown they do not,” said Anthony Conroy, head of trading at BNY ConvergEx.
The mania was apparent in the run-up to the Nasdaq collapse, when individuals gave up steady jobs to become “day traders” in the hope of making fortunes from soaring shares. That particular road to riches came to an abrupt halt and the role of individual traders in the stock market has been much more marginal ever since.
The bursting of the bubble had a huge impact on the business of financing technology start-ups. But it went much further than that. Arguably, the dotcom boom ushered in the historically low interest rates from the Federal Reserve that are now widely blamed for allowing the housing and credit bubbles. It also paved the way for lightly regulated hedge funds to succeed mainstream mutual funds as the critical drivers of the market.
The bubble itself was largely driven by what the former Fed chairman Alan Greenspan called “irrational exuberance” – increasing investment by retail investors in stocks, either through mutual funds or through fledgling internet brokerages. Many of these investors, egged on by widespread television advertising, only entered near the top of the market and suffered severe losses. This dented the market influence of mutual fund managers.
“I don’t think we have ever seen such a point when so many people from Main Street were involved in the market to that degree,” says James Paulsen, chief investment officer of Wells Capital.
The Nasdaq crash coincided with a drop in the broader US stock market, but it was relatively localised. Outside technology, media and telecommunications, stock valuations were high but not extreme.
Given the scale of the crash, it was therefore surprisingly easy to avoid losing money. Hedge funds, which unlike mutual funds can protect themselves by selling short or by switching between asset classes, managed to perform adequately while mainstream investors were suffering.
Between 2000 and 2002, the S&P 500 lost 9.1 per cent, 11.9 per cent, and 22.1 per cent in successive years. Most mutual funds followed the index downwards. Meanwhile, hedge funds (as measured by Hedge Fund Research, a big Chicago-based research group) gained 4.98 and 4.6 per cent before succumbing to a small loss of 1.45 per cent in 2002.
Only relatively wealthy individuals can invest in hedge funds, so there was no big flow directly from mutual funds. But big investment institutions, also burned by the Nasdaq crash, noticed the success of hedge funds and started to pour money in. In 2002, more than $99bn came into the hedge fund industry, according to Hedge Fund Research, at the same time that small investors, shaken by the market falls, were pulling a net $24.7bn out of mutual funds.
The number of hedge funds also proliferated. In 1998, when the near-meltdown of Long-Term Capital Management briefly appeared to have inflicted critical injuries on the sector, there were 3,325 funds; by 2007 there were more than 10,000.
In 2005, after four years of persistent inflows, the entire hedge fund industry was worth more than $1,000bn for the first time. Two years later the industry’s assets would peak at more than $1,800bn.
However, this probably understated hedge funds’ influence, thanks to another effect of the Nasdaq crash. Hedge funds also benefit from their ability to use leverage. Trades that are barely worth making become very profitable once they have been leveraged up many times over with borrowed money.
The Federal Reserve’s reaction to the Nasdaq crash made it much easier to obtain leverage. Heedful of the economic pain that had followed the bursting of previous big investment bubbles, in the US in 1929 and in Japan in 1990, the Fed decided to cut interest rates aggressively. It did this even though much of the economy was relatively unaffected by the dotcom sector’s problems, and the effect was to make it far easier to borrow money for speculation - whether to run a hedge fund or to buy a house.
Thus hedge funds’ real buying power was multiplied several times by leverage, and they came to drive stocks and other asset classes, on a daily basis. The patterns of trading that ended with the global crisis of 2007-09 all arguably had their roots in the fall-out from the dotcom crash.
None of this meant that all tech companies turned out to be a bad investment. Google, arguably the single biggest winner from the internet, did not even go public until four years after the bubble burst. Shares in Amazon, by far the most successful internet retailer, hit an all-time high of $142 in December 2009, well above their dotcom period peak of $89. However, very many of the companies that copied it, and that briefly turned their founders into multi-millionaires, ceased to exist long ago.
Technology has also been one of the strongest performers of the last 12 months. It has not lost its allure ten years later. Counting out specific technology companies and sectors, such as robotics in medicine, would be unwise.
“Tech constantly gives rise to more cutting edge and innovative companies than any other industry,” says Mr Paulsen. “You do have mature cycle tech companies, but it also the place where you find the next growth stocks.”
Betting on the Nasdaq rising beyond 5,000 still looks a stretch. “We can have great returns in tech, but it will not get us back to 5,000 in a hurry,” says Mr Paulsen. “That high - 5,000 - is a testament to how absurd the bubble really was.”
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