The Tech Bubble....

In my Money Week column this week, I've been looking at the bubble in tech stocks. Here's a taster.

Right now, everyone in the markets is worrying about bubbles. It might be commodity prices, it might be bonds, it could be gold, or it could be the emerging markets. They are all up strongly in the past year. They all look as if they might have over-reached themselves.
But one distinguishing characteristic of a bubble is that no one really notices it. If everyone is complaining about the price of a particular type of asset, it is probably in perfectly good shape. It is the bubbles you haven’t seen that are likely to catch you out.
What are they? In a replay of 1998 and 1999, it might well be technology. Amazon is trading on a price earnings ratio of almost 70. Apple is now the third biggest company in the world. Google just keeps going up in price. And Facebook, if it ever comes to the market will be valued at billions.
And yet despite the explosive growth of the internet economy, all the old problems remain. Business models are flimsy, the barriers to entry are wafer-thin, and the technology moves so fast, it is hard for investors to make any money.
When the post-credit crunch bull market comes to a screeching halt, as it inevitably will at some point, it well be a technology crash that bring it down.
No one would deny that internet is now a huge business. That was underlined by a report by the Boston Consulting Group published last month. It found that in the UK alone, the online economy was now worth £100 billion a year, and accounted for 7.2% of GDP. If it was a separate economic sector, it would be bigger than construction, transport or the utilities.
Britain is not particularly advanced in its take-up of technology. What is true in this country will be true in every other advanced economy as well. This is a huge and growing chunk of the global economy.
It is absolutely right, therefore, that the companies that dominate the space should be sought after by investors. Anyone looking for long-term growth is going to want to own a slice of the leaders of the technology boom. Otherwise they risk getting left behind.
But hold on. Just because a company has good long-term growth prospects does not mean it is worth absolutely anything.
Take Amazon, for example. It was one of the pioneers of online retailing, and remains the best brand in that industry. I’d be surprised if there was a single reader of this magazine who wasn’t also an Amazon customer. Its latest figures were terrific: sales were ahead by 16% and profits were ahead by 39%. No doubt it will have a great Christmas. Even so, its share price has gone crazy. They have jumped from $25 a share in 2005 to $170 now. It is trading on multiple of 69 historic earnings, and 49 times the forecast earnings for next year.
Or take Apple. Sure, the iPhone is a big hit, and the iPad has been making a lot of noise. In the last five years it has got just about everything right, and there is probably no other business around that has so many devoted customers. Even so, there must be a limit to what it is worth. The shares are up by more than 50% this year alone. With a market cap of $290 billion, it is the second most valuable American business. It is the third most valuable company in the world, after Exxon Mobil and PetroChina. This, remember, is a company which, while it dominates the market for MP3 players, currently has just 4.1% of the mobile phone market, and slightly over 5% of the global market for personal computers. Those are hardly dominant market positions – but you would hardly guess that from its share price.
Much the same could be said of Google, or Facebook, or many smaller technology companies. They are good businesses, in a fast-growing sector of the economy. But they are also hitting crazy prices.
The trouble is, all the old problems with technology and internet companies remain.
For starters, there are still far too few barriers to entry. The days when a few bright Harvard students could start a website that would blow apart the industry, in the way that Mark Zuckerberg did when he started Facebook in 2004, may be over. Then again, they may not be. This is still an industry in its infancy. It is very easy for a few bright people to turn the web upside down with very little money to play with. That is great for them, and it is what makes high-tech so exciting. But is it very worrying for shareholders in the established companies. It is just too easy for a young entrepreneur to come along and blow you away.
Next, there are still relatively few sustainable business models. The online retailers make money, but often only by squeezing their suppliers to the bone. The internet is the most ruthless price comparison device ever invented, and one consequence of that is that margins will always be wafer thin. Businesses like Google may have a great advertising franchise right now – but there is no limit to ad space on the web in the way there is in the physical world. In truth, all online business models remain very flimsy.
Lastly, the technology moves so fast it is very hard for shareholders to make money. The founders and the venture capitalists who back them usually do pretty well. But by the time a company gets to the quoted market, its best days may already be behind it. It may never get to the stage of paying out steady dividends. Even Microsoft only paid its first dividend in 2003. Neither Google or Amazon have ever paid a dividend, nor are they planning to do so. By the time they do, they will probably look as far past their sell-by date as Microsoft does.
In reality, the tech rally looks overdone. It is bound to come shuddering down to earth again some time soon. And when it happens, it may well prove a trigger for a wider market correction.

Will Stocks Survive September?

In my Money Week column this week, I've been looking at whether there is going to be a correction to the stockmarket rally in September and October. Here's a taster....


The autumn has always been a scary season for the stock market. From the Great Crash of 1929, in October of that year, to the crash of 1987, also in October, to the collapse of Lehman Brothers, in September last year, it has always been the season when investors step up to the abyss, look down, and for some odd reason decide to hurl themselves straight into it.
And this year? Get ready for a September Surprise. After the strong rally of the last six months, the markets are poised for a brutal autumn correction. Companies are going to be looking to the markets for vast quantities of cash; the boost provided by stimulus spending is going to fade; the emerging markets are about to come juddering back down to earth; and, in the UK at least, there is likely to be a renewed bout of political turmoil as Gordon Brown’s dismal premiership enters its last, rockiest months. All four factors are likely to be make the next two months a bumpy ride for investors.
No one can have failed to notice the strong performance of the markets in the last five months – even if plenty of people were too slow to take advantage of it. In the US, the S&P 500 index has rallied by 49%over that period. Most of the other markets around the world have performed just as strongly. China’s Shanghai Composite Index, the best performing major index, is up by 78% so far this year. Even the UK’s FTSE, which hasn’t been one of the better performing markets for years, is up by 11% over the last six months even though the British economy shows few real signs of climbing out of recession. The MSCI World Index, probably the most accurate gage of global sentiment, has climbed 54% from a 13-year low touched in March.
But can it last? The historical precedents aren’t good. September has always been the worst months for US stocks: taking an average of every year since 1928, stocks have fallen by 1.3% during that month. The only other month that is such a consistent loser for investors is February. Some of the Septembers along the way have pretty scary. Last year, for example, the S&P fell by 9% following the collapse of Lehman Brothers. Back in September 1931, as the depression started to acquire that rather frightening looking ‘great’ in front of it, stocks fell by 30 percent, wiping out all the gains from the bounce back after 1929.
Even if you happen to get through September unscathed, there is always October to worry about. The precedents of 1929 and 1987 suggest that can be just as brutal a month for investors.
Of course, those are all just co-incidences. Just because the autumn has often been hard on the markets in the past doesn’t mean that it will be this year. Still, there are four reasons for thinking there is a surprise in store for investors this September, and it won’t be a pleasant one.
First, companies are desperate for cash. Lloyds Bank suggested last weekend it would be tapping the markets for money to replace the state as a shareholder, and that is just one example among many. There are lots of battered balance sheets out there, and the stock market is just about the only place where funds can be raised to put them back into shape. Already there have been 315 IPO’s this year as deals frozen in the credit crunch get bought back to life. But all that extra stock coming onto the market is going to soak up available funds, and will stop prices from rising as fast as they have been.
Next, the initial impact of the stimulus programmes put in place by governments around the world will start to fade. Even a patient near death will perk up if given a massive injection of adrenaline, but that doesn’t tell you very much about their underlying health. It would be a surprise if big increases in government spending, central banks printing money like crazy, and record-low interest rates, had not revived the economy. But governments can only shift spending from one period to another. They can’t permanently increase it. Over the next six months the impact of all those stimulus programmes is going to fade out of the system, revealing economies that are very weak underneath it. When that happens, investors are going to have a nasty fright.
Thirdly, this rally has been led upwards by the emerging markets. It is the Chinese, Brazilian, Indian and Russian markets that have led the upswing, the so-called BRIC economies. No surprise there. With high-saving rates, rapid industrialisation, and hard-working labour forces they look a far better bet than the developed economies of Europe and North America. Yet they remain volatile, and gains of 70% or more in a year are likely to be checked. When they are, investors around the world will take fright. Without the BRICs to drive it, there are very few reasons for feeling optimistic about the global economy.
Lastly, the UK has some political turbulence ahead. Gordon Brown’s government will limp miserably into the last political season before its demise. Don’t assume that Brown will survive: the Labour Party shows little will to live right now, but it must know it is being led to slaughter. Even without a change of Prime Minister, as he election campaign gets underway, as it will once the party conference season opens, the currency and gilts market may well wobble. Neither party shows much willingness to discuss the scale of the fiscal crisis the UK faces, and at some point that will make anyone holding assets in sterling feel nervous.
Whether the last five months were just a bear market rally, as the sceptics will tell you, or whether they were the foothills of a genuine bull market, no one can say for certain. There are good arguments on both sides of the issue. But one thing is for sure. Market never move either up or down in a straight line. Whichever it is, there will be bumps and reversals along the way. This market is due a correction. And September is the most likely time for it to kick-in.

The Rally Has Legs....

In Money Week this week, I've been arguing that the stockmarket rally can last for quite a while yet, although not for the reason most people think. Here's a taster....

Seldom can a stock market rally have been greeted with such universal scorn. As shares around the world picked themselves up off the floor, dusted themselves off, and started to show some signs of renewed life, they were greeted with a chorus of boos and catcalls.
All the usual caveats were duly trotted out. Sucker’s rally, the said. A bear market blip, warned the chart-wielding experts. Nothing more than a dead cat bounce, declared the sages. From the disdain heaped upon what was in fact a modest recovery, you’d think most people want the stock market to remain flat on its back.
Actually, they are dead wrong. The rally is real enough. There are plenty of good, solid reasons for stocks to start climbing again, and the investors who get behind it will do just fine. There is just one snag. The recovery is taking place for all the wrong reasons. It doesn’t signal that the global economy is in any better shape than it was a few months ago. It signals that inflation is heading down the line, that printing money is igniting a fresh bubble, and that the stock market is one of the very few places you can protect yourself against that.
There is no mistaking the way that shares have recovered.
In the US, the S&P 500 index staged its steepest nine-week rally since the 1930s, rising 37% from the twelve-year-low it reached back in March. Financial stocks led the way, with a 23% rise last week alone as the stress tests set by the Obama Administration were passed with ease.
The MSCI Asia Pacific Index is up by 38% since its low point back in March. The Hong Kong market by itself is up by 52%. Here in Europe, the FTSE 100 index has soared 27 percent from its March 3rd low, and is now just about in positive territory for the year. The Dow Jones Stoxx 600 Index, measuring the main European companies, is up by 33% since its March 9th low. It too has erased all its losses in the early part of the year.
That is not exactly ‘green shoots’. It is more like a whole garden blooming with daffodils and tulips. By any measure, it is a remarkable recovery, particularly since only at the start of the year we were being told the global economy was poised on the brink of the worst downturn since the 1930s.
Naturally, many people aren’t convinced. Many of the reasons put forward for the rally were about as convincing as an MP’s expenses claim. We were told that the US economy was still shrinking, only not quite so fast as it was a few weeks ago, which hardly seemed much of a cause for joyous celebration. Business leaders were lined up to argue that their sales weren’t quite as bad as they expected, which, again, hardly seemed enough to mark share prices up by a quarter. After all, economies are still getting smaller. Company profits are still getting hit.
There has certainly been no evidence of a return to robust growth to provide some solid foundations to the rally. Not surprisingly, that opened up a field day for stock market historians. Plenty of people were quick to remind us that US stocks bounced 50% in the first few months of Franklin Roosevelt’s reign, hardly am auspicious comparison.
And yet, the rally is perfectly justified. It is just that there is nothing comforting about it.
Investors have looked at the policies of ‘quantitative easing’ announced by central banks around the world. They have seen the way the Bank of England has just said it will pump and extra £50 billion in freshly minted pound notes into the economy in the next few months. And they have noticed that even the European Central Bank, previously heir to the stern anti-inflationary hawks of the Bundesbank, has joined the party, with its own plans to create more euros. And they have drawn the right conclusion. ‘QE’, or printing money as it should be called, is going to have two consequences, both of which will be good for equity prices.
The first is that it will create inflation further down the line. There is little escaping that conclusion – more money, poured into a shrinking economy, has to raise prices. The only refuge from that for investors is in real assets.
Gold is one possibility, although there is very little evidence left to suppose the metal has any monetary value. Property is another, although the markets are so depressed and the companies so debt-laded it may take them years to recover. That leaves blue-chip companies. In a climate of moderately accelerating inflation, where prices start pushing up 5% to 6% a year, which is what we are heading for, strong and powerful companies should be able to gently nudge up their prices, profits and dividends. Stocks will inflate along with everything else.
Indeed, we can already see that in the companies leading the way. The rally in the FTSE, for example, has been led by sectors such as industrial miners, banks and retailers – precisely the kind of companies that will do well out of inflation.
Next, there is already evidence that QE is spilling out into another asset bubble. If you print money, it has to go somewhere – nobody throws the stuff away. It was meant to be pushing down bond yields, but there isn’t much sign of that (bond yields have been rising modestly). In fact, all the fresh cash is slipping into the equity markets. Central banks are determined to re-flate the bubble. And it looks as if they are starting to succeed.
In truth, printing money is not going do much for the long-term health of the global economy. That will depend on the same things its has always depended on: free trade, deregulated markets, low-ish taxes, and the rate of technological progress. But it will create inflation, and it will create asset bubbles. And that’s a good basis for a stock market rally, even if it is bad news for everything else.