An important measure of the strength of the tech sector has been climbing rapidly over the past two years and surpassed its turn of the millennium level in June. This doesn’t mean there is another tech bubble, but investors should take heed.
From 1995 to 2000, millions of US households purchased personal computers and used them to connect to the internet for the first time. It was apparent at the time that new technologies, often from government origins, were bringing massive changes. Private investment poured into the tech sector, including to many companies that had never generated a profit and even some without revenue. Money coming into the sector began to overflow and pour back out in the form of lavish executive spending and absurd demonstrations of wealth. When the speculative “dot-com” bubble burst, people lost jobs and retirement savings.
The tech pulse index, produced by the Federal Reserve Bank of San Francisco, tracks what is going on in the tech sector by looking at relevant changes in investment, employment, industrial production, and consumer spending. The index nearly tripled from 1995 to its peak in October 2000, growing at an average annualized rate of 18.7 percent. By the bubble’s trough in 2003, the measure had fallen to nearly half of its peak. From the 2003 trough until the recent uptick in 2016 the index increased at an average annualized rate of 2.9 percent.
The tech pulse has been on a tear since 2016. From May 2016 to the latest data, covering July 2018, the index has increased at an average annualized rate of 11.4 percent. In June, the index passed its January 2000 level, and it is currently about 13 percent below the all-time high achieved at the peak of the bubble.
There are many similarities between the current tech boom and the dot-com bubble, such as: absurd demonstrations of wealth, the failure to convert money coming in into new productive assets, a backdrop of rising interests rates, and highly-valued companies not generating profit. In some cases, valuations are so high that it seems people are betting not necessarily on tech companies ability to create game-changing technology, which is already priced in, but on their ability to either force competitors to fail or to absorb competitors until market share allows for monopoly prices and monopsony wages. In some cases, the competitor is a public good, such as local and regional public transportation in the case of Uber and Telsa, respectively. Once our public asset is taken over or goes broke and stops operating, the private alternative can raise its prices and allow its quality to deteriorate.
In the case of Amazon, which currently generates a profit mostly through its web services division, investors seem to be betting that eventually the company will have enough power to raise prices without consumers being able (or willing) to shop elsewhere. It’s also worth noting that Amazon got where it is by not paying sales tax. Apple and Alphabet (Google), which already generate massive amounts of profit, still benefit excessively from not paying taxes.
While I don’t know whether the current tech boom is a bubble, and I lean towards thinking it is not, it’s always good to be cautious and to pay attention to growth rates, like those captured in the very clever tech pulse index (here’s info on the methodology). In general, investors should be wary about buying into companies that are already expensive and where the remaining upside requires the alignment of several events in the unknowable future.