Investor Profile - Holy Investments, Inc.

THE INTERNET “BUBBLE BURST” AND ITS LIKELY IMPACT ON FUTURE INVESTING - by William Peterseim, CFP®, CMFC

If you were invested in the stock market early in 2000 and remained, like most, invested through the following three year nightmare, you very likely sustained considerable losses. Referred to now as “The Internet Bubble Burst”, it didn’t appear as such at the time. “Monday morning quarterbacking” makes experts of us all…in retrospect.

At the time we had a “bubble” but there appeared no visible “burst”. Rather, a succession of small “holes” appeared in this large bubble but, in the short term, each also appeared to be “plugged”, only to have others open. We didn’t go straight down. We encountered on-going minor appearances of “recovery” only to give false hope before the next decline. The general mindset in Mid-March was that we were experiencing another “correction”. You expect these periodically in Bull Markets. We’d had a number before.

A “correction” is defined as a pullback or retrenchment by the market of at least 10%. It doesn’t get serious or become any real concern unless and until it hits 20% at which point it is called a Bear Market. This rarely occurs and, although U.S. Bull Markets historically run for 2-5 years, Bear Markets neither fully retrench to pre-Bull levels nor last beyond 18-24 months. This time, however, things were different.

“Heady times” called for broad-based optimism. It was quite frankly difficult to find an investor really concerned. In speaking with clients, many told me not to worry, that they weren’t. “Heh! The market always comes back. And, when it does, it moves on to greater heights, new levels not previously seen”. Yes, that certainly did appear to be the case for years.

Add to this the fact that we had not seen two years of back-to-back losses in the Market since 1973-4 and we hadn’t seen three years back-to-back declines since 1939-41.

To illustrate the level of investor confidence present by the late 90’s, consider these facts:

In nationwide investor surveys conducted as late as 1998, investors overwhelmingly stated that they expected average annual returns to continue in excess of 12% - 15%. Up until that time, it was fairly routine, when interviewing new clients, to find that most would be content to earn that average. That wasn’t terribly out of line or too much to expect, as the long-term average stock market performance was a tad over 11%. By long-term, I mean over the preceding 60 years or so.

The issue started to become a concern when in late 1999 current surveys were revealing a startling change in attitude amongst investors. By the new millennium, investors now routinely expected annual returns, even in their mutual funds , of no less than 25% - 30% and, for the most part, expected many years to be higher than that. Indeed it seemed possible, given all the industry talk about there being a “New Economy”.

This New Economy was, as stated, brought about by the advent of the life and economic changing Internet. Well, life was simply not going to be the same. Markets were different. Retail was a whole new game. Therefore, it made no sense to expect the “normal” or historic indicators we’d come to rely upon in the stock market to remain.

P/E ratios were fairly passé. (P/E is the ratio of a stock’s Price (P) to, or divided by its Earnings (as annualized). Granted, P/Es of Tech (Technology) stocks are generally much higher (30-50) than those of large established, non-growth industrials like Ford or GM whose traditional P/Es were 8-12). But, while P/Es of 30-50 might be acceptable in 1998, more investors and even brokers and advisors were shrugging off or willing to accept P/Es in the hundreds by some newer internet plays with strong projected growth. And, we were told that such P/Es were part of the New Economy and not an aberration.

Problem was, these theorists and analysts were wrong . There was no “new economy” only the perception of such. In 2002, I was one of roughly 20 invited to attend a presentation in Cleveland , Ohio by a renowned Economist. In that presentation, he stated that the bursting of the Internet Bubble was predictable. And, to prove his point, he cited a number of prior events mirroring those of 2000 going back over 200 years.

He showed with charts and graphs that each major advent in technology was accompanied by a euphoria and talk of “a new economy” (where have we heard that?). In each case, this led to major run ups in the stock market which were inexorably followed immediately by a crash of major proportions. (See: stock market 2000-2003…and take a Kleenex).

In each case, the old standards ultimately prevailed. Fundamentals remained. Investors still came back to believing that, eventually, companies, if companies want to survive and have their stocks taken seriously, needed to actually sell product or service and earn money. I know, that’s earth shattering, but true. Investors will go along with the dream and the hype only so long until they fall back on the old reliable concepts.

The story of Amazon.com is a classic. At one point in early 2000 a guest in my office had done an analysis which showed that, in order for Amazon to justify its current price, it had to increase sales every quarter by something like 20% for the next 20 years. Unlikely at best and certainly grounds to dump the stock as severely overpriced but, few did. Buying continued, and it didn’t just burst, it blew.

[For a very interesting story relating to Amazon and the theory and perceptions surrounding STOCK SPLITS see my upcoming article on Stock Splits.]

Back to the Economist and his presentation.

So, in the end, “Everything’s old and nothing ain’t new” as the song goes. The bottom line to his analysis was that, and you’re NOT going to like this ….historically there is no rapid recovery from the crash following the unrealistic market run up on “new economy” technological developments. These developments occurred with the impact of the Industrial Revolution in America , with the advent of entirely new industries such as automotives and aviation, and so forth. It often took years if not decades to see the market return to pre-crash highs. So, those middle-agers and beyond among us may not see a full recovery in our lifetimes. Sad, and hopefully not true.

After sitting through the presentation and studying the materials, I did have to ask one thing of our visiting Economist. And, in my family, with my two zany daughters, I have learned all too often that answers to many of life’s great questions are often found, or at least delivered in lines from movies…that they are prone to memorize and with which they torment me. I rarely get a straight answer. It is usually a line and I must, in order to get the full explanation, first guess the movie and character. (Don’t you hate it when kids you brought into the world turn on you like this?)

So, I raised my hand and, when called on, responded with a line from Adam Sandler’s “The Wedding Singer” in the scene in which his fiancé, who stood him up at the altar the day before, (see: they’ve even got me doing it) came to his home to explain, albeit belatedly, why she decided she just was in love with Robby the performer but not Robby the….Wedding Singer. His response, now a classic oft used by yours truly, was… “That’s the kind of information that would’ve been extremely useful…. YESTERDAY ! ”

That was my response to the Economist as I cited the fact that we were appearing, hopefully, to near the BOTTOM of a nearly three year nightmare at that point in 2002. WHY ? I asked, were we only NOW hearing all of this? “That’s the kind of information that would’ve been extremely useful…. YESTERDAY! ” As in maybe TWO years ago.

So, even with the Economist, I question whether, while he said the event was predictable, in fact he DID predict it or, in its bloody aftermath, got inquisitive and looked up the data and saw a pattern that might indeed be valid but entirely too late to help anyone. Again like rewriting Sunday’s Playbook Monday morning. And, since these events are often separated by at least 60 years, who knows if it will help any of us? Our only hope is that with technology progressing at an unheard of pace today compared to any other time in history, we may see a repeat with some other major technological leap this next decade. Who knows?

I do hope this article has provided you some insight on what happened and what is likely NOT to happen anytime soon. It was not my intent to leave you without hope, so make sure to check this site again within a few days as I will post new articles including strategies on investing in the current uncertain market . One thing I have learned from all of this is that what worked yesterday, in large part, is NOT working today. Savvy investors must, therefore, adapt to new markets and conditions in order to attempt to make up losses or stay ahead of the game. Giving up completely and retrenching into bank accounts paying 1%-3% isn’t the answer either.

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