Can investors learn from history? Next month will mark the 20th anniversary of the peak of the dotcom bubble, triggering huge value destruction in stockmarkets. Few portfolios escaped unharmed. A perspective of two decades can guide better judgement today. Indeed, today’s world may not be so different – 2000 has lessons that all investors should keep front of mind.
Not all that happened in the bubble was wrong. Certainly, many valuations were driven to ridiculous heights for business models that lacked any real edge. Accounting flexibility helped this, and stockmarkets lost track of real cashflow. But, some businesses from that era - such as Amazon - survived to become today’s big winners. That has not only generated great profitability, but also created a strong defensive moat leading to dominance in new areas such as cloud services. And, in this month 20 years’ ago, investors were beginning to rotate their interest into traditional sectors such as banks. RBS, for example, doubled over the next 7 years. Arguably, the banking boom, and the easy monetary policy that followed the end of that bubble in 2008 sowed the seeds for today’s global economy.
Low interest rates and cheap borrowing fuel today’s stockmarkets. But when that ends and how, is hard to predict. Cynically, many investors are betting that politicians will find new ways to stimulate economic growth in future, just as it is becoming clearer that cheap money distorts economies and undermines social fabric. Already, investor interest has moved a little from growth stocks into value.
At the same time, some growth businesses have moved to stratospheric ratings. Shares in Tesla, for example, have more than quadrupled from their lows last summer. But, who would rule out the possibility of Tesla pivoting into new areas – much as Apple, Microsoft and Google have achieved over the years. Bubbles only look easy to unpick with hindsight.
Today’s investment challenge is not cashflow, but genuine growth. Share buybacks, and takeovers followed by cost cutting, seem to create little lasting value - even if share prices are boosted short term. And, although the internet stocks of 2000 mostly failed, technology today still looks like the future. Many private businesses – often driven by digital and mobile business models - are readily attracting new capital and growing. In contrast, the largest listed companies of the FTSE 100 are struggling to deal with disruption. Most need to restructure and cut costs.
In 2000, hard assets were a guide – goodwill and a lack of underlying physical capital often pointed to problems. But today - in a global economy driven more by people, data and low-capital business models - physical assets matter less. Good business models can scale-up rapidly, and reach a mass market of online or mobile customers cheaply. In contrast, many traditional businesses with huge asset bases may in fact be unable to earn an economic return on that capital - particularly if it represents an outdated business model. The opportunity in those businesses may be where cashflow allows a business model to evolve; oil companies and utilities could turn into attractive renewables businesses or spin-out those divisions.
One pattern - evident in the dotcom boom and the banking crisis - that is still present is accounting distortion. Investors need to pay close attention to divergence between the profits determined by accounting standards and the usually better adjusted headline numbers.
With hindsight, it seems that bubbles can last much longer than seems rational, but unwind rapidly. Spreading a portfolio across a range of asset types can help, but a stockmarket sell-off can drag down everything. The best protection for a portfolio in an extended bull market is to check that it remains grounded in reality, with companies that have genuine sustainable competitive advantage.
A version of this article was published in The Herald on 22/02/2020.