Investment Outlook: Third Quarter 2020 "Party Like it's 1999"

“It’s wonderful to promote new industries because they are very promotable. It’s very hard to promote investment in a mundane product. It’s much easier to promote an esoteric product, even particularly one with losses, because there’s no quantitative guideline.” Warren Buffett, July 1999

Today, there is excessive “promotion” in technology and new concept stocks that is eerily like 1999, a year when the tech-heavy Nasdaq index rose an astonishing 85%. The amount of money raised from new initial public offerings is on track to exceed the amount raised in 1999. Today we see very high valuations of companies with a short track record and some without any profits. The public is all-in on this, as people quarantined at home from COVID with less live sports to watch have turned to stock trading as amusement. Investors shun mundane businesses but love unproven new concepts.

September 18th, 2020’s Wall Street Journal included a list of high-flying stocks, showing not the price-to-earnings ratios (because many on the list do not yet have any earnings), but the price to projected revenues for the next 12 months. These include newly-public Snowflake at 70 times revenues, Zoom Video at 35 times, Shopify at 30 times. Hot stock Tesla, the maker of electric cars, did not make the list at only 12 times revenues. Mundane Ford and GM each have a market cap of less than one year’s annual revenues.

The speculation of 1999 was a culmination of the advance of personal computers, the internet, and the Black-Berry. Like now, the interest in technology had logical beginnings, but it ended with excessive expectations that most companies would be unable to fulfill. Cisco Systems, the maker of the hardware that built the internet, was the poster child of the 1999 tech bubble. When the average stock was trading at 15 times earnings, Cisco was valued at 120 times earnings at its peak of $80 per share, a price it has never since exceeded.

Another iconic ‘99 stock is AOL, aka America-On-Line (one of the first dial-up services). AOL reached a market cap of $224 Billion in 2000, was later acquired by Time Warner, then was sold to Verizon for $4.4 Billion, who recently wrote off most of that $4.4 Billion to complete AOL’s round trip back to zero. Unfortunately, neither Cisco, AOL nor many others could provide the growth that was expected by those who paid sky-high prices for their stock. How many of today’s companies will live up to the high expectations that are implied by their sky-high valuations? As evidenced in 1999, this year’s group faces long odds. It turned out that P/E’s did matter. How long will this 2020 party last? Today the mega-capitalization tech stocks such as Apple, Microsoft, Google/Alphabet, and Facebook appear to be less at risk than this year’s newly public companies, as they generally sell for around 30 - 35 times forward earnings estimates. This valuation is rational when they are still growing at 20% per year and the competition from interest rates is non-existent.

As to when the next overall bear market arrives, that is a much more difficult question. In 1999, the non-technology sectors did not participate in the bubble, so their declines were much more modest than the tech stocks. That is like today with the non-tech sectors selling at sensible valuations in this era of very low-interest rates. A major downward adjustment in overall stock valuations looks to be farther in the future when the easy money policies might come to an end.