When a bubble forms, it often isn't just novice retail investors who get burned chasing some of the bubble's hottest companies and assets. Many fund managers and other institutional investors also end up getting hit pretty hard.
The reason this happens is that for many of the companies that are bid up to nosebleed valuations during the bubble, investor enthusiasm isn't necessarily fueled by pie-in-the-sky promises about how some product, service or technology will one day generate massive sales and profits.
Rather, it's often fueled by more complex bullish narratives about companies that are already seeing tremendous sales growth -- and sometimes, tremendous profit growth as well -- and which are expected to continue delivering strong growth for many years to come. Narratives that have a knack for reeling in more sophisticated investors just as much as they tend to win over novice investors trading from a brand-new online brokerage account.
The 1999/2000 bubble that formed among the proverbial "pick-and-shovel" providers for the Dot.com/telecom gold rush is a good example of this phenomenon. While many of the Internet startups and debt-financed telcos that existed during the bubble were seeing heavy cash burn, the companies seen as pick-and-shovel providers -- think equipment suppliers such as Juniper Networks (JNPR) and Ciena (CIEN) , or chip and component suppliers such as PMC-Sierra and JDS Uniphase -- were both seeing massive sales growth and making money hand-over-fist.
And in the eyes of the institutional and retail investors who were willing to pay triple-digit forward P/Es to own these names, these companies were a safe bet to keep delivering strong top-line growth in the coming years. Even if some money-losing dot-coms and telcos went belly-up, these investors wagered, the pick-and-shovel providers would keep doing well as Internet traffic growth drove higher demand for their wares.
The 2007/2008 commodities bubble, which burned quite a few hedge funds, was similar in some ways. Many of the investors who bid up commodity futures and crowded into the shares of miners and oil and gas firms saw that era's U.S. housing bubble for what it was. But they were sure that commodities prices -- and with them, the shares of the companies responsible for extracting commodities from the earth -- would remain high thanks to narratives about scarce global supplies (remember "peak oil" predictions?) and massive demand growth within China and other emerging markets.
Looking at today's tech stock landscape, it's not hard to see some parallels between the attitudes held by dot-com pick-and-shovel providers in the summer of 2000 or commodity investors in the spring of 2008, and the ones currently held by investors willing to pay very steep valuations for high-growth software and Internet names.
Much like bulls during the aforementioned bubbles, investors are willing to pay sky-high multiples to own companies such as Shopify (SHOP) , Zoom (ZM) , Coupa Software (COUP) and Fastly (FSLY) because they're convinced -- thanks to secular growth drivers rising SaaS spend, higher e-commerce penetration rates and growing video consumption -- these companies are guaranteed to deliver strong double-digit growth for many more years. And also like investors in those prior bubbles, they see select high-growth companies as safe havens at a time when business risks clearly abound for various other companies.
Likewise, just as the narratives that formed around, say, telecom equipment suppliers in early 2000 or oil producers in early 2008, overlooked genuine business risks (e.g., telecom capex plunging following a period of massive overinvestment, commodities prices and demand falling sharply thanks to a global recession), investors bidding the likes of Shopify and Coupa to the moon might be overlooking genuine macro and demand risks.
Among these risks: Larger corporate layoffs and IT spending cuts due to continued macro pressures, weaker consumer spending due to high unemployment and a smaller stimulus boost, some of the retail spending that has recently shifted to e-commerce going back to offline channels and efforts by companies that have seen major increases in the number of SaaS apps they're paying for to consolidate their software spend.
None of these similarities mean that high-multiple software and Internet companies will end up crashing the way that telecom equipment firms or oil producers once did. For example, instead of a crash, we could (if macro and secular demand conditions are favorable) get an extended period of gradual multiple compression as high-multiple software and Internet firms grow into their current valuations over the next few years.
But at the same time, the parallels between some of the bullish attitudes expressed today and some of the ones expressed in 2000 and 2008 shouldn't be overlooked. Nor should it be forgotten how the bullish attitudes during those prior bubbles were embraced by experienced and inexperienced investors alike.
