If you’ve been watching the last one-and-a-half-year’s tech stock rollercoaster with an odd sense of déjà vu, you’re not alone. There are some strong parallels between today’s tech sector and what went down when the dot-com bubble burst back in 2000. And those similarities—rising stock valuations, an increase in initial public offerings (IPOs), and a focus on buzz over basics, followed by high volatility and a sharp drop in Nasdaq year to date—have some experts wondering if history is repeating.
But what caused the dot-com crisis?
The frenzy of buying internet-based stocks was overwhelming, as many internet-based companies, so-called dotcoms, were starting up. As they were in a fairly high-growth industry, they needed funding. Funding came primarily from venture capitalists while lenders and enthusiastic individual investors drawn by the hype also followed later.
Instead of focusing on the fundamental company analysis involving the study of company revenue generation potential and business plans, industry analysis, market trend analysis, and P/E ratio, many investors focused on the wrong metrics such as traffic growth to their website propelled by the startup companies.
Outrageous valuations were placed on these companies, and share prices continued to fly high as demand was overwhelming. Therefore, the explosion of the bubble was inevitable and resulted in a market crash, which was more discernible on the NASDAQ Stock Exchange.
The dotcom bubble crash was a shock event that resulted in massive sell-offs of stocks, as demand lessened and restrictions on venture financing increased the rate of the downturn. Inevitably, the crash also resulted in massive layoffs in the technology sector.
The dotcom bubble started collapsing in 1999, and the fall precipitated from March 2000 until 2002. Many popular dotcom companies (including Kozmo.com, eToys.com, and Excite) went bust or were acquired by other companies. Equities entered a bear market and the Nasdaq didn’t return to its peak until 2015.
What does the past teach us?
• Diversification matters. Taking a look on the impact the dot-com crisis had on Private Markets we see that diversity across sectors, asset classes as well as different vintages can be a significant protector to a portfolio.
• Ignoring investment basics is dangerous. Even as the stock market began its meltdown in 2000, individual investors—caught up in the rush to riches—continued to dump money into equity funds. And many failed to do their homework and research the stocks they were buying. Prices didn’t always reflect underlying business performance. Most of the new public companies weren’t profitable, but investors ignored poor fundamentals and increasing warnings about overvalued prices.
• Momentum is intricate. Tech stocks rallied in the late 1990s because the internet was new and everybody wanted a piece of the next big thing. But when the reality set in that some of those dot-com rising starts weren’t going to make it, and others would take years to turn a profit, the momentum faded. Investors who got in late or held on too long—out of greed or panic—came up empty-handed.
Is it happening again? Unfortunately, there’s really no way to know when an asset bubble will burst or how severe the fallout might be. As always, attention to fundamentals is paramount and a diversified portfolio provides downside protection and absorbs abrupt market swings.
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