I remember the tech stock bubble of 2000 like it was yesterday. Maybe you do too.
We were all so excited about the prospect of what the internet would do for the world, we threw prudence out the investing window and bought technology stocks hand over fist. The world was crazy for tech stocks, and people were leaving their careers to “day trade” tech stocks from home. It was a new paradigm where traditional metrics that have guided investing forever were abandoned in favor of rationalizations for buying companies whose valuations made no sense. And we all made good money investing in thrilling companies. Man, that was a fun time. Until it wasn’t.
We entered a bear market for stocks in March of 2000 and over the ensuing year and a half, tech stocks, as measured by the tech-heavy Nasdaq composite index, lost nearly 80% of their value. It would take 15 1/2 before the Nasdaq hit a new high. The irony is that the internet today actually exceeded our wildest dreams from back then. And yet, if you’d invested in nearly any one of the large railroad company stocks in 2000, you’d have about 10 times more money today compared with an investment in just about any of the popular tech stocks in 2000. But you would have been derided as a heretic for making such a suggestion back then.
Why take this painful trip down memory lane? Well, there is a resurgent interest in tech stocks of late, and their behavior harkens back to what went through 20 years ago. It brings to mind the great philosophical pondering of Yogi Berra. Is this “deja vu all over again?”
Certainly, there are similarities in the behavior of tech stocks today that are reminiscent of the bubble. This year, while the Dow Jones Industrial Average is down 5% (as of this writing), the Nasdaq composite is up 19%. The five largest stocks in the S&P 500 (Microsoft, Apple, Amazon, Facebook and Google) now make up 25% of its weighted performance, and the average return of these stocks this year is 36%. Oh, and Tesla is up 275% and its value is now greater than Ford, General Motors, Toyota and Honda — combined.
Did I mention we were in the worst recession since the Great Depression?
So is this a 2000 redux? As Mark Twain said, “history doesn’t repeat itself, but it often rhymes.” I think that’s an apt framework. Things are familiar, but things are different. While you’ll never hear this investment manager make the case for why big tech is cheap today, valuations are nowhere near those of its predecessors back in the day. Excluding Amazon, the average price-to-earnings (P/E) ratio of the other four big tech stocks is about 30. In 2000, the leading tech stocks traded well above 100 P/E. A primary reason is that today’s leading tech stocks make good money — back then, we were betting of the prospect, not the proof, of future earnings.
Today, interest and inflation rates are much lower, which elevates the value of future earnings on a discounted and inflation-adjusted basis. In 2000, the inflation rate was 3.5% and the 10-year Treasury yield was 6.5%. Today, those stats are 0.7% and 0.6%, respectively.
Does that mean things can’t end badly for big tech like they did 20 years ago? No, I’m not saying that. It’s quite possible tech stocks lag the broad market over the next few years as we recover from the recession. But applying the outcome of the bubble to what’s happening today is going too far. It’s unlikely that tech stocks will fall by 80% in the foreseeable future, their recent stunning out-performance notwithstanding.
The point of this is not to put too fine a point on the future — none of us know exactly what will happen until it does—and I could be wrong. The more important point, then, is to apply the lesson from last time, so we don’t do unacceptable damage should the market roll over from here.
The biggest lesson from 2000 was that the more you allocated to tech stocks, the more pain you felt. Now is not the time to abandon tech stocks, but it’s really not the time to be overloaded in them. Technology stocks make up 25% of the broad market. If your tech weight is 50%, you’ve doubled the bet. If you’re shy about tech, for the reasons mentioned, you might cut that 25% in half to 12.5%. If you own other investments, like bonds, your tech weight should be reframed for the adjusted stock allocation.
Having invested through the 2000s, you don’t want to have to wait 15 1/2 years to earn your money back.