Everything You Need to Know about Tulips, Bubbles, and Bulls

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It’s a tale that students of economics know all too well. With a demand craze in the market for a particular good heightening the price of an item, unrealistic speculation can occur to the point that this good becomes grossly overpriced without being able to justify its new value. The resulting mania, often called a bubble, can manifest in the market for this good and cause all sorts of losses when this bubble bursts. Many people understand this concept in reference to the Tulip Mania incident that was seen in Holland during the 1600’s, after the overvaluation of tulip prices reached its peak and soon plummeted when investors panicked from the overvaluation that had been occurring.

This hard lesson has been taught time and time again as well as even recently with the housing bubble that burst in 2008; but 15 years ago, investors in technology companies found themselves in a similar situation as Dutch tulip investors, when over-speculation in this market created a bubble that’s often referred to as the dotcom bubble. Soon after the crash, the US economy slipped into a recession, which leaves many to see just how big such an overvaluation in one industry can be for the overall economy of a nation.

Today, many investors still have a bad taste in their mouths from this major failure in the system, however technology companies such as Apple and Google boast a great deal of promise that many fear could lead to a resurgence of the dotcom bubble which plagued the late 90’s and early 2000’s.

NasdaqThe bull market for technology can be best represented by looking at the performance of the Nasdaq Composite Index, a “tech-heavy” compilation of 3000 companies that give a snapshot of performance in one particular area of the economy. This index has shown a 4% increase in 2015 and is expected to once more outperform the S&P 500 for the 6th time in the past 8 years.

This high degree of performance can be attributed to the massive tech giants that compose this index such as Amazon, Google, Microsoft, and Apple. However the same speculation that reared its ugly head in the dotcom crisis years ago wasn’t backed by the same, sustainable company cash flows such as what tech-firms produce today.

Liam Pleven and  Liz Moyer of The Wall Street Journal explain in their article, The New Tech-Stock Temptation,

“At the end of 1999, the top 10 firms in the Nasdaq were worth $2.2 trillion, with $26.4 billion in earnings, according to Ned Davis Research, which is based in Venice, Fla. As of the end of February, the top 10 are worth a bit more—$2.6 trillion—but make roughly five times as much money, $131.2 billion.”       

The other major factor that makes technology companies different today, than 15 years ago, is that there is a difference between a dotcom start-up trying to capitalize on a short-term fad and a company with a clearly defined service/product that is taking advantage of advances in technology in order deliver something faster, better, or cheaper to consumers. This is often the air around modern tech companies, such as Netflix, who has shown to have benefited from the development of smart-TVs, an increase in economies of network for the internet,  and even a more innovative product design that gives viewers movies/shows at a fraction of the price that competitors charge. Factset reports that Netflix has shown an increase in stock price of 33% this year.The video streaming company represents yet another of the Nasdaq’s listed companies outperforming expected levels once again.

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Furthermore, riskier companies such as Twitter have been excluded from the Nasdaq as these companies may be a closer representation of a fad in technology, not an accurate image of the industry as a whole. This is another key aspect of the index that makes it different today than in the 90’s. The more exclusive atmosphere also shows that the financial sector, as well as investors seem to understand the technology industry much more than they did in the past. Regardless, Twitter still seems promising despite the fact that stock price is down 1.41% today after rising 10 points at the end of January.

So, with looking at the Nasdaq and the companies that compose this index, we see a similar trend that spelled disaster in the past many times before. Yes, the tech-industry has its share of bulls as does the Nasdaq, however these companies are gaining massive profits unlike any technology company ever before, and it’s not just unrealistic hype. Google has forever changed search engines with its advanced crawler algorithm. Amazon has transformed online shopping on a scale to actually compete with or even replace physical stores; and Apple not only has introduced a new concept, the smart phone, but it continues to grow as a juggernaut in the industry by taking on projects with cloud storage, innovative software, synchronized products, voice and fingerprint technology, and even rumors about a car that drives itself. Needless to say, these companies have substance and directly affect everything we do on a daily basis. So with all of this understood, I think it’s safe to say that these tech-companies are not over-speculated mania due to a bull market for the short-term; and the Nasdaq is not an indicator of a bubble that will pop any time soon.

Sources: Yahoo Finance, The Wall Street Journal, Investopedia, We Make Mints, Factset

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