Though it often gets forgotten when investors and financial writers talk about the bursting of the Dot.com bubble, the market's initial crash in the spring of 2000 didn't spell the end of the party for many tech stocks.
After dropping 41% from a March 10 high of 5,132 to a May 24 low of 3,042 in, the Nasdaq regained about 60% of its losses over the next couple of months, reaching a level of 4,252 on July 14. And the index would remain close to that level for the rest of that summer, briefly taking out its July high on Sep. 1.
Perhaps more importantly, quite a few tech companies approached or took out their March highs that summer. This list included networking hardware vendors such as Cisco Systems (CSCO) and Juniper Networks (JNPR) , IT hardware firms such as Dell and EMC, telecom/networking chip suppliers such as Applied Micro Circuits and PMC-Sierra and optical component vendors such as JDS Uniphase and SDL (in hindsight, JDS' $41 billion, all-stock deal that summer to buy SDL was one of the bubble's more spectacular events).
You probably know what happened next. Between Sep. 2000 to April 2001, the Nasdaq lost over 60% of its value, with virtually no tech company spared from the carnage. And it would be more than a decade before the index approached 4,000 again.
Given that there are a host of differences between the current market, macro and monetary policy environments and the ones that existed 20 years ago, I'm definitely not going to predict that the Nasdaq is going to see a wipe-out similar to what it saw in the fall of 2000 and winter of 2001, never mind predict that it will take more than a decade for the Nasdaq to return to its Feb. 2020 high. But there are one or two parallels between the current environment and the summer of 2000, and so there might be a lesson to be taken from what happened back then.
An Extended 2000 Bubble for 'Pick and Shovel' Providers
While March 2000 represented the bubble's high point for investor enthusiasm towards Internet companies -- particularly Internet companies with very shaky business models and financials -- enthusiasm for companies seen as providing "picks and shovels" for the Internet and telecom capex booms that were taking place at that time remained strong for a while longer.
Though unprofitable Dot.coms such as Pets.com and Webvan were questionable investments, this line of thinking went, the profitable and fast-growing companies supplying servers, storage and software -- both to the Dot.coms and to the traditional enterprises that were making big IT investments at the time -- would be just fine in the months and years to come. So would the networking hardware companies selling switches and routers to debt-financed telcos who were investing heavily to support the mammoth Internet traffic increases that were expected in the coming years. And so, of course, would the companies supplying chips and components to IT and telecom hardware vendors.
Such attitudes, together with the continued arrival of strong earnings reports, allowed the aforementioned companies to keep trading at sky-high valuations during the summer of 2000. But their shares began slipping in September and October as signs emerged that IT hardware and telecom equipment sales growth was slipping a little, and that many of the telcos that were spending so much on hardware faced financial challenges.
And the bottom truly fell out in the following months as it became clear to all that a tremendous amount of IT and telecom overinvestment had happened. By the time that the Nasdaq hit a short-term bottom of 1,619 on April 4, 2001, many hardware, chip and component suppliers were reporting major sales declines.
Similarities and Differences Between Now and Then
As the Nasdaq trades 33% above its March 23 low -- and just 10% below its Feb. 19 high -- in spite of the economic upheaval caused by the COVID-19 pandemic, there are some pretty clear differences between the current environment and the summer of 2000. First and foremost, the business and macro risks posed by a giant capex bubble are different from those posed by a public health crisis that has upended a lot of everyday consumer and business activity, but is for now at least giving a boost to certain tech businesses.
Second, while valuations currently look stretched for many Internet and enterprise software names, multiples haven't gotten out of hand to the same degree that they did in 2000, and (with the qualifier that projecting future sales and earnings is quite challenging right now) there are still a decent number of names trading at moderate trailing EPS and free cash flow (FCF) multiples.
Third, whereas the Fed was arguably asleep at the wheel for much of 2000 as signs of macro deterioration emerged, raising interest rates during the first half of the year and keeping them steady during the second half, it has pulled out all the stops in response to help deal with COVID-19's economic fallout. And there has also of course been a giant fiscal stimulus response, with more likely to come.
But there is one important similarity between the current environment and the summer of 2000: A lot of investors are convinced that the "right" tech companies will be just fine even as other tech companies, as well as some of the customers of the "right" companies, deal with major financial challenges. And as a result, these companies have often recovered most or all of the losses they saw during an initial crash.
Eventually, the challenges faced by money-losing Dot.coms and debt-laden telcos took a toll on the equipment, chip and component companies relying on them. So did the fact that a lot of financially healthier companies had also purchased far more hardware than they needed.
Along similar lines, the current environment carries the risk that -- with COVID-19 likely to continue disrupting consumer and business activities in the coming months -- the financial woes of companies in industries such as travel, energy, auto and hospitality are going to weigh on many of the tech companies directly or indirectly relying on them. And there's also a real risk that consumer spending in fields such as e-commerce and tech/electronics hardware, which is currently benefiting from stimulus payments and much lower discretionary spending on things such as travel and dining/entertainment, softens in the coming months.
Throw in the fact that valuations for many favored tech companies are (though generally not at 2000 levels) pricing in a lot of future growth, and there's a real risk that these companies could sell off hard if signs start emerging that macro pressures are going to weigh on their sales for an extended period of time -- even if any such selloff is pretty unlikely to be as bad as what happened in 2000 and 2001.
