After more than 25 years in investment management, I am still amazed at the speed and efficiency by which the stock market operates, with the instantaneous unification of supply and demand and the resulting equilibrium pricing. However, as I wrote in my book, Taking Stock, this seemingly efficient market increasingly goes through such intense highs and lows that manic may be a better way to describe its true nature. That manic nature is why the market sometimes gets it wrong, especially during a period of frenzied IPO activity such as we have been experiencing.
Shades of 2000
I’m not necessarily sounding the alarm just yet, the market conditions that have spurred near-record IPO activity this year are eerily similar to 2000, just before the historic bursting of the dot com stocks. While the total number of IPOs in 2020 is far less than in 2000 – due in large part because of the brief bear market and the five-month economic shutdown – the IPO activity starting in August and peaking in December is as frantic as it was in February 2000, one month before the dot com bubble burst.
Generally, past performance does not indicate future performance, but there may be exceptions to the rule. For example, right now, the market is experiencing a wave of investor exuberance only seen in the lead-up to previous bubbles. It’s when that exuberance is fueled by herd behavior and nothing else that one should be concerned. When I say, “nothing else,” I’m referring to the complete lack of fundamental metrics that warrant the stratospheric valuations we see today.
It’s been said that we aren’t likely to experience the likes of the dot com bubble because the lessons have been learned. Have they? Back then, companies that had yet to generate revenue, let alone profits went IPO at staggering valuations leading to feeding frenzies for investors who drove their stock prices even higher, by as much as 300% on the day of the IPO. More than 370 of these dot com IPOs in 2000 raised more than $1.5 trillion.
The bubble finally burst when several high-tech companies, such as Cisco and Dell, began to unload their own stock to capture their high valuations, thereby causing a panic among investors. At that point, the capital quickly dried-up, leaving cash-strapped dot com companies to wither and die. By the end of 2001, most publicly traded dot com companies folded, and trillions of dollars of investment capital evaporated.
“History doesn’t repeat itself but it often rhymes.” Mark Twain
Fast forward twenty years to an unprecedented stock market, which saw the shortest bear market in modern history and the most rapid recovery to record highs. During the last six months of 2020, the market surged to record highs, ultimately creating the conditions for a strong IPO market. However, there is a big difference between the 2020 and 2000 IPOs in that most of the bigger ones, such as Airbnb and DoorDash, are more established with growing revenues and earnings.
Like some of the established tech companies in 2000, such as Amazon and Microsoft, many of these companies aren’t likely to go under when the next bubble bursts. However, as long as their valuations continue to defy logic and financial gravity, there should be cause for concern. This IPO market’s intensity is reflective of 2000 when a clear disconnect existed between dot com stocks and the rest of the market.
What if You Could Just Ignore the Next Bubble?
As with those stocks, the valuations of 2020 IPOs have gotten so high that they offer little if any upside for investors. And because valuations always return to their mean over the long-term, it becomes just a matter of time before the herd changes course and heads for the hills. That’s when the bubble bursts.
As with the dot com bubble and ensuing market crash, not all companies that get caught up in the next market contagion are necessarily bad investments. Following the dot com fiasco, companies with a real product and strong business performance were terrific investments because their prices fell well below their intrinsic value. Companies like Apple and Microsoft could be purchased at steep discounts.
As long as you don’t get caught up in the exuberance of the moment, you are in a much better position to ride out the next big storm. It’s a good time to stay cautious when others become more optimistic. When optimism turns to pessimism, it’s time to look for opportunities. With that mindset, you can simply ignore the next bubble. If it does burst, you will likely find great companies selling at great prices to fortify your portfolio against the next bubble.
