Is That a Tech Bubble I See?

Some think technology stocks are poised for a 2000-style crash. And if they aren't, they may be soon.

David Rosenberg
David Rosenberg
Is that a bubble taking shape? Are tech stocks safe?
Is that a bubble taking shape? Are tech stocks safe?Credit: Ilan Assayag
David Rosenberg
David Rosenberg

What is it about financial bubbles that make them so hard to detect?

One reason is that memories are short. Some 20 years ago Wall Street merrily poured into technology stocks, and was horribly burned. Not many years later, the rest of America piled into residential real estate with similar abandon, and similar results.

Israel seems less prone to that irrational exuberance that seems to characterize America. We had the bank shares bubble in the 1980s and Jacob Frenkel, when he was Bank of Israel governor, popped one in the early1990s, but nothing since.

But that doesn't mean Israel doesn't pay the price for America's mistakes.

The tech bubble's demise in 2000 together with the outbreak of the Second Intifada sent the Israeli economy into a tailspin, striking a direct blow at our then emerging high-tech sector. The financial crisis of 2008 that arose from America's housing bubble did us less damage because it had no direct impact, but the fact is it also slowed economic growth.

So we do have an interest in the debate underway in America and Europe right now over whether the run-up in technology shares and then their recent comedown is a second tech bubble playing itself out.

Frothy signs and red ink

Bubble or not, the big increase in valuations for technology stocks on Wall Street and in London have percolated back to the distant shores of the Eastern Mediterranean. Israeli companies have been raising money in initial public offerings at levels not seen, coincidentally or not, since the last technology bubble. Interestingly, of the five Israeli IPOs in New York this year, four are companies losing money, of which two have no significant revenues at all. Those are signs of an irrational market for tech stocks, say bubble watchers.

Meanwhile, big tech companies are using their stock to fund eye-popping mergers and acquisitions, most famously Facebook's $19 billion takeover of WhatsApp in February (of which $12 billion is in Facebook shares).

All that IPO and M&A activity filters down to the tiny startups working in Tel Aviv, which can dream – and reasonably expect - to raise millions in venture capital funding, then to cash out.

Would Waze have been worth close to $1 billion in normal times? Probably Google itself couldn't say. But the impact of the number – even if it wasn't quite $1 billion and wasn't the biggest-ever buyout of an Israeli company – was enough to bring new attention and presumably new money and higher valuations to Startup Nation.

No, says Goldman

So is there a tech bubble, or isn't there? David Kostin, Goldman Sachs' chief U.S. equity strategist, says not.

Tech stocks aren't overvalued, he claims: the market is more balanced now than it was in 2000. Back then, tech stocks accounted for 14% of all earnings in the S&P 500, but a third of the index's capitalization. Nowadays the two figures are about the same at 19%.

Nor is the IPO market a-boil like it was 15 years ago, Kostin says. In the first quarter of 2000, 115 companies went public, raising $18 billion; in the first quarter of this year, 63 IPOs raised $11billion.

Moreover, a report by Fischer Investments notes, the IPO market isn't as crazed as it was 15 years ago: The first day run-up in share prices after their IPO is a third of what is was in 2000, evidence that investors haven't lost all sense of proportion.

Kostin and his fellow bubble-doubters have a lot of other arguments, but suffice it to say that they are based principally on examining the numbers.

Every bubble is unique

The problem is that bubbles – tech and otherwise – can easily be analyzed away. To misquote Tolstoy, "Real bull markets are all alike; every bubble is a bubble in its own way." No one expects the tech bubble to explode using exactly the same formula it did 14 years ago.

Tech is more bubble-prone than other industries. Investing by nature is betting on the future, but in the case of tech - the future is a growth story based on extracting a brilliant future from a cool idea. No one buys shares in a breakfast cereal maker because the company promises to "disrupt" morning eating habits or because it has impressive snap-crackle-and-pop per user ratios.

But in tech - just take this example: Of the 48 tech and biotech IPOs on Wall Street this year, 43 were in companies that had yet to show a profit, says Jay Ritter, a University of Florida academic who follows such trends. Nevertheless, the average first-day increase for their share prices was 26%.

The price Facebook paid for WhatsApp works out to $42 per user even though at this stage WhatsApp has no revenues beyond a symbolic $1 fee it collects the second year a user is signed on.

Tech isn't all smoke and mirrors. As Fischer Investments points out, the transition to cloud and mobile computing is driving demand for all kinds of equipment, devices and services. U.S. business is stepping up spending on information technology, with investment in reaching an all-time high in the final quarter of 2013. Emerging markets are opening up new opportunities. The Internet is more ubiquitous than was in 2000 thanks to mobile and ever-greater bandwidth.

Even the more speculative area of tech – social media, e-commerce and the like – is real business. But only a few companies have the bulk in the form of capital, depth of management and a sufficient user base for any investor to make a calculated bet on their ability to capitalize on them.

The evidence right now doesn't quite add up to a bubble in the process of exploding. But it certainly looks like one in the making that will explode in a year or two, when its been sufficiently puffed up.

Indeed, the latest market downturn looks to be more of a correction than a collapse, which will only make the bubble-deniers more confident that no dangers lurk ahead.

Israel's Startup Nation doesn't have giants like Google and Apple that can weather a 2000-style downturn. It does have lots of small, speculative startups that could easily be sunk by a tech-market collapse. Israel's tech sector should exploit the bubble for what it's worth by stocking up on a capital while its cheap and plentiful - but gear up for the worst.



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