Wednesday, 17 March 2010

The Lessons From The Dot Com Crash

In my Money Week column last week, I was looking at the lessons to be learnt from the dot com bubble ten years on. Here's a taster....

Ten Years On, Investors Should Make Sure They’ve Learned The Right Lessons From the Dot Com Bubble:

It is a statistic to make any investor feel sober. On March 10th, 2000, the Nasdaq index in the US hit the giddy heights of 5,132. Dot come mania was at its peak, and the key American technology market just kept on soaring.
Until, like all bubbles, it suddenly burst. After reaching that peak, the Nasdaq went into a steep decline that made even the drop in the Japanese Nikkei index in the 1990s look relatively benign by comparison. By 2002, it had plunged all the way back down to 1,300 wiping out three quarters of its value in around eighteen month. The dot com bubble, of which the Nasdaq was always the best measure, had well and truly burst.
A decade on, what should investors learn from that?
Two lessons are important. That bubbles, for all the madness and hype that gets associated with them, usually contain an important grain of truth. And that just because something is over-hyped, it doesn’t mean you can afford to ignore it – a lesson that clearly applies to China and the rest of the BRIC economies right now.
The dot com bubble was one of the greatest investment manias of recent times. Future economic historians will no doubt cast it along with Dutch tulips as one of the best examples of a capitalist system going completely haywire.
And, in truth, there was a lot of madness around. For a time, it seemed like any vaguely plausible young man or women, with smartly pressed chinos, an open-necked shirt, and a convincing patter about ‘eyeballs’, ‘land grabs’ and ‘first-mover advantages’ could load themselves up with a few million in venture capital, and turn that into an IPO a few months later. Mundane matters like actually having any revenues, or indeed any real knowledge of how to build a website, could be conveniently forgotten. In the ‘new economy’ everything seemed possible.
It is no great surprise that many of the dreams turned to dust. Investors, inevitably, lost a huge amount of money. And yet, looking back with the perspective of a decade, it is striking not just how crazy it all got, but also how much truth there was in many of the claims made at the height of the bubble.
The internet genuinely was a disruptive technology. Take a look at the way that newspapers are starting to close around the world. Observe the plight of once mighty record labels like EMI. Scan your high street for a CD store, a bookshop, or a travel agent. They are all gone. Big industries have been consigned to history. Others have been changed completely. Nor has the process stopped. Internet-enabled mobile are only just starting to reach the mass market. Plenty more industries will be changed forever before the impact of the web has played itself out.
Likewise, it really was a ‘land grab’. Want to launch a web book store against Amazon, an auction site against E-Bay, or a search engine against Google? Forget it. Those companies completely dominate their space, brushing aside all competitors. They will be the great monopolists of the twenty-first century – and precisely because they got in their early, and, if necessary, spent big money to establish themselves.
The only thing the evangelists for the ‘new economy’ really got wrong was the timing. It all took a bit longer than they predicted – and even on that they were only out for by a few years.
In reality, the dot com boom was more like the railway boom of the 1880’s or the mania for electrical stocks in the 1920s, which led up to the great crash of 1929, than the tulip craze. Railways had a huge economic impact. So did electricity. Just like those bubbles, the dot com boom took something of genuine importance, and magnified it to ridiculous proportions.
There is an important lesson in that for investors.
Take a look around the world right now and there are plenty of bubbles. British house prices, for example. Or government bonds. Or equities in China, or any of the other emerging markets giants, such as Brazil, Russia and India.
Some of them are just bonkers. It is hard to see why British house prices are higher than they were before the credit crunch hit – when they should be much lower. It is equally hard to believe that it makes sense to lend money for ten years to a practically bankrupt Spanish or Italian – or indeed British - government at rates of around 4%.
Those are just bubbles. You don’t want to go anywhere near them.
But the BRICs? That’s different. Sure, it’s hard to value stock accurately in China. We’re not sure we really believe the growth figures the government in Beijing publishes, never mind the price earnings ratios that appear on the Shanghai bourse. We have no real idea whether Brazil can grow in the next decade the way it did in the last, whether Russia is at long last a stable democracy, or whether India can complete the journey to modernity. We may well look back on the mania for the BRIC stock markets in 2020 and wonder what on earth we were thinking.
It is however unlikely we won’t think anything of significance was going on. In truth, the BRIC economies have passed the point of no return. They may not turn into Switzerland in the next decade, but they are too far along the path of industrialisation to go back to being agricultural, resource economies. With combined populations of 2.8 billion, that is going to have a massive impact on the global economy.
They key lesson is very simple. Don’t get fooled by the bubble. But also don’t get blinded by the fact it’s a bubble into thinking that nothing of importance is happening. The lesson of the dot com bubble – like the railway and electrical bubble before it – is that just because a trend is oversold, it doesn’t mean it isn’t significant. And right now, that is most obviously true of the BRICs.

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