Business »

Tech bubble brewing? Analysts are divided

H.S. Borji
Share on StockTwits
Published on
www.finances.com
Tech bubble brewing? Analysts are divided

On Thursday finances.com gauged the prospects of a technology bubble in an article entitled, “Is a Tech Bubble Brewing?” The article noted the recent 14-year high of the tech-heavy Nasdaq 100 and cautioned investors social media stocks such as Twitter (NYSE:TWTR) may be overvalued.

“So are social media stocks in a bubble?” asked David Becker in the July 10 article. “With companies such as Twitter (NYSE:TWTR) showing no price to earnings ratio as they do not produce a bottom line, their relative value seems extraordinarily high. When compared to the Nasdaq highs of the year 2000, Twitter seems to be in a bubble.”

Debates about whether or not a stock market bubble is forming are not always useful, since there isn’t a universally agreed upon standard for value. What one analyst might consider a bubble another might consider sustained growth. Given that the stock market has had very few peaks and valleys since the 1999-2000 dot-com burst, differentiating between a boom and a bubble isn’t always easy.

Adding to the complexity is the 2008 financial crash, which resulted in the worst economic downturn since the Great Depression. With the memory of the 2008 financial collapse fresh in the minds of investors, fears about a stock market bubble are bound to sway sentiment when the major indices are routinely setting fresh all-time highs.

Investors interested in determining whether the current technology market is headed toward another historic speculative bubble should reflect on the crash of 1999-2000. It offers lessons about what to expect when a bubble is forming.

To better understand the context, recall that the word “dotcom” was the answer to a lot of the world’s problems at the turn of the 21st century. The internet, which was created by the United States military, became commercially relevant by 1995. Very soon it became an international market that was described as the new economy.

“Dotcom” became a market buzzword, as investors all over the world abandoned fundamentals in favour of big ideas and new paradigms. So when the initial public offerings of internet companies came on to the scene, investors couldn’t get enough. Pretty soon every Tom, Dick and Harry with a “dotcom” IPO was relevant.

Beneath the euphoria, however, were volatile internet companies that were hemorrhaging money. Some even folded months after their IPOs were launched. Others experienced tremendous growth and even more devastating losses in a short period. Of course, investors didn’t care and were drawn to anything that satisfied their “dotcom” appetite.

In 1999, a total of 457 IPOs were issued, with the majority belonging to internet and technology-related stocks. Among those 457 IPOs, 25 percent saw their share prices double on the first day of trading. By 2001, the number of IPOs had fallen to 76 and none of them doubled in value on the first day of trading.

The bursting of the bubble saw the tech-heavy Nasdaq composite fall from 5,046.86 to 1,114.11, as Silicon Valley shed 200,000 jobs. The impact of the burst pulled the US economy into recession.

Looking at today’s technology sector, it’s difficult to draw direct comparisons to the late-1990s, but some of the main features that defined the sector then are still relevant today. For starters, the tech sector is one of the most dynamic, fast-evolving industries in the world. Perhaps no other industry has changed the lives of people more than technology. Therefore, the rise of emerging technologies such as cloud computing, smartphones and tablets, supercomputing and big data are creating almost as much excitement as the internet did more than a decade ago.

As we saw in 1999-2000, bubbles reflect investor sentiment, and it was very hard then, like it is today, not to be excited about emerging technologies.

Technologies such as mobile and cloud are justifying big bets in Silicon Valley and on Wall Street, as many believe these transformative platforms still have ample room to grow.

Earlier this year Facebook (NASDAQ:FB) announced it would buy virtual reality company Oculus VR for $2 billion. Just five weeks earlier the social media giant announced a $19 billion acquisition of the popular instant messaging service WhatsApp.

Shares of King Entertainment (NYSE:KING) , the developer of popular mobile game Candy Crush, issued an IPO of $22.50 earlier this year, giving the company a market valuation of $7.1 billion. The offering was the largest US IPO from the mobile gaming industry since Zynga Inc (NASDAQ:ZNGA) .

Meanwhile, Box Inc – a cloud computing company – recently announced plans to raise $250 million through an IPO, despite operating on a growing deficit.

And who can forget the rise of the revenue-less Cynk Technology Corp (OTCMKTS:CYNK), which recently shot up 25,000 percent after trading for pennies for most of its existence. According to an article published Thursday by finances.com, the company has no product, no revenue and only one employee. According to the company’s most recent quarterly financial report, it has just $39 in assets and nearly $52,000 in liabilities.

Little else is known about the company, who was recently suspended by the Security and Exchange Commission for “potentially manipulative transactions.”

Cynk investors may have gotten cold feet, as the company’s sudden price drop Thursday occurred with only 245,000 shares being traded amid reports the company was being investigated by regulators.

The company, which is reportedly headed by Marlon Sanchez, has a market capitalization of more than $4 billion at the time of writing. While some of argued this is a clear case of “pump and dump” – a method of artificially inflating the price of an owned stock – the stock’s meteoric climb could also be a sign of the markets overvaluing tech startups, another common ingredient in a technology bubble.

Still, other will argue that some of the biggest technology companies in the world are trading well below their record highs, and that shenanigans such as Cynk offer little proof the market is in a bubble. Bigger companies like Microsoft (NASDAQ:MSFT) and Oracle (NYSE:ORCL) have not seen their share prices inflate wildly, and even Facebook struggled out of the gate as investors questioned its growth outlook.

Looking at the numbers, it could be a while still before a bubble truly materializes. Stock market bubbles go vertical, and the pace of the markets hasn’t demonstrated those trends just yet.

According to a July 7 article from Investor’s Business Daily, the Standard & Poor’s 500 index in April was around the same level as it was in in past peaks (early 2000 and late 2007). The S&P 500 is now around 5 percent higher than the April level.

At the same time, however, it’s difficult not to be somewhat concerned about the broader stock market. The US Federal Reserve, which is considered one of the biggest contributors to market bubbles in modern times, has injected more than $4 trillion into the US economy since 2008. The massive dollar-generating central bank is in the final phase of its quantitative easing program.

At the June Federal Open Market Committee policy meetings the central bank decided to trim its holdings of Treasuries and mortgage-backed securities by another $10 billion. This means that, beginning in July, the central bank would ease $35 billion per month into the financial markets.

The minutes of the June meetings, released earlier this week, indicated the Fed was ready to end its record bond buying scheme after the October meetings. There were no mentions of market bubbles in the latest minutes, but there was concern about growing risks in the financial markets due to improper risk management.

The stock markets have hit record highs under quantitative easing, which has its fair share of critics in Congress and on Wall Street. Excessively high unemployment and an uneven labour market are among the biggest challenges the Fed currently faces. These challenges may have convinced the Fed prolonged stimulus was needed to get the economy back on track.

Senator and potential Republican presidential candidate Rand Paul is worried the Fed’s stimulus program has created a false recovery, one that is “illusionary.”

Investors convinced the stock market is in a bubble won’t have many viable trading strategies available to them. Investors could close their portfolios and wait for stocks to drop before buying, but it’s impossible to know how long they’d have to wait.

The biggest challenge with a market bubble is knowing when the correction will occur, not to mention the potentially devastating impact for publicly traded companies and the broader economy. At this juncture, analysts appear divided about whether or not the stock market is bubbling out of control, or whether the markets are in a period of sustained growth buoyed by investor optimism and exciting growth opportunities.

Share on StockTwits