Are We Having Flashbacks? « Up Capital Management

27
Nov

Are We Having Flashbacks?

In March of 2000, the NASDAQ and every “dot.com” company began to disintegrate. For the year, NASDAQ declined 39% and 49% from its March peak. Unfortunately, the carnage had just begun as the tech sector continued to decline for another two years. Many investors and employees holding stock options were devasted from massive layoffs, bankruptcies, company closures, and financial ruin. While experiencing this first hand in Silicon Valley, it was difficult to watch the impact of the tech crash on friends, neighbors, and family. The only consolation (for those that stayed) was almost no traffic delays due to the mass exodus of people returning to their former hometowns and countries. It was a tragic end to a seemingly magical time of expanding corporate and personal wealth with soaring record-breaking stock prices. For years, the NASDAQ was blasting past new all-time highs on a weekly basis. From January 1997 to March 2000, the NASDAQ rallied over 275% peaking on March 8, 2000, only to plummet 95% ending with a 4.4% gain for the seven-year period.

Are we experiencing the same early signs of an imploding tech sector and the rest of the economy? After all, it was only eight years after the tech crash that the stock market and real estate crashed (2008), and now it is eight(ish) years since the bottom. Many beg the question that the timing seems right for another crash (Nyle tackled that issue in a previous UPdate). Also, similar to the 1990s of astronomical stock gains are the articles from earlier this year predicting which company will be the first to reach a trillion-dollar valuation (Apple followed by Amazon), and now the FAANG stocks (Facebook, Amazon, Apple, Netflix, Google) have lost over $1 trillion in market capitalization since their summertime peak. This month alone the FAANG stock group has lost over $400 million in valuation (*).

Are we having flashbacks to the last tech crash? I am confident we are not. Here are my five key rationales:

(1) Many of the tech companies that imploded during the 2000 tech crash had short-lived existence typically with no profits, and some without even any revenue. Those companies that survived this crash which still exist today had sustainable businesses and profits. Granted that “all boats” rose during the 1990’s rally and many well above historical averages, their stock decline eventually bottomed and rallied back above previous highs years later. Investors are indicating with sell orders that the FAANG stocks and many other growth stocks have to exceed realistic valuations. However, this selloff has brought the overall stock market valuations below long-term averages referencing the share price of stocks to each dollar of revenue.

(2) Speaking of revenue, unlike many companies during the 2000 bust, companies today are making money and at all-time levels. This year, the average increase in profits for all of the S&P 500 is projected to exceed 20%, this is not just tech companies but companies over a wide landscape of industries. All of the FAANG stocks are profitable and currently flush in cash with combined cash and short-term investments approaching $500 billion (enough to pay 50% of US 2018 deficit).

(3) The “exuberance” in the 1990’s stock market expressed by former Fed Chairman, Alan Greenspan, doesn’t exist in today’s market. Only a few years later did the residential real estate market implode due to the same frenzied over-bought scenario that skyrocketed home prices to ridiculous levels. However, today’s market is far from being “exuberant” with investors buying at any price. If anything, it is hard to believe the stock market has survived as well as it has this year with the relentless critiques about Washington, tariffs, slowing foreign economies, and rising Fed rates; just to name a few. Technically, the S&P 500 P/E (price to earnings) ratio is below its historical average, and Relative Strength Index (RSI) is approaching its long-term support level – a typical buying indicator.

Another key technical consideration of the S&P 500 is the current double bottom chart. This same cycle began in Q3 2015 and finished in Q2 2016. An essential favorable characteristic of a “double bottom” is when the second selloff drops below the previous low. This historically takes out the last of “exuberance” and sets the stage for investors to begin buying and rebuilding portfolios as stock values are now attractive.

(4) The economy is growing not contracting. Today’s unemployment rate is lower than even the best of 1990 years and has more room to grow. Not since 1969 has the current unemployment rate reached 3.7% combined with net new job growth exceeding 200,000 per month. Early positive reports of Black Friday and Cyber-Monday are indicating strong holiday retail sales and potentially good news for Q4 profit reports in January. Most importantly, 2016 was the beginning of the next (or current) expansion cycle compared to the bust in 2000 which ended its previous cycle. That 18-year expansion cycle (1982 to 2000) saw the DJIA rise 1100% from 1,000 to 11,497, annualized compounded return of about 14%, compared to 59% increase during the 16-year contraction cycle (2000 to 2016) with the annualized compounded return of about 3%.

(5) This is going to be the obvious answer, we are simply nowhere near the same levels of drawdowns. Although the big FAANG stocks may be down -20%, the overall market has only experienced two 10% drawdowns in the past two years. On average, markets experience a -14% decline every year. Unfortunately, 2017 may have changed people’s risk appetite as everyone seemed to be making money, even the cryptocurrencies! THAT is not normal, the current correction is.

WHAT DOES THIS MEAN TO ME?

They say wealth is built through concentration and preserved through diversification. Volatility in the market tends to come in clusters, and we will not be surprised to see more gyrations in December. However, when we zoom out a bit, look at the macro picture, and think long-term, we are much more comfortable with our financial goals and the instruments that have been tailored to see us to our destination. We encourage you to click the button below to establish (or reestablish) your risk score. Why? Because evaluating your comfort level during bull markets is as important as evaluating it during pullbacks, and we want to invest precisely.
We hope you had a great Thanksgiving and look forward to connecting soon!

(*) As reported by Barron’s November 26, 2018

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