Economic Crisis

Welcome back to the late 1990s

Recently I’ve had this feeling that we’re back in the late 1990s. It’s not that Bill Clinton is messing about with interns at the White House, or that Tony Blair is playing to the cameras after another royal car crash. No. It’s more serious. A lot of financial conditions nowadays look similar to that time. It’s helpful for investors today to understand this, and what happened next.

Let’s start with the building blocks of our comfortable modern lives: commodities. Today we’re once again in a world of weak commodity prices, just like in the late 1990s. There’s also a strong US dollar, also like the late 1990s (see here for charts). But there’s a lot of other stuff that looks familiar as well.

US stocks are still trading at very inflated prices relative to just about any measure you care to think of (see here for more). We’re not quite at the insane levels of the tech bubble top in March 2000. But we’re already well into the territory of the late 1990s, just before the final mania and bust.

In other words, yet again investors are expecting companies to generate dollar profits that are well ahead of the likely reality.

Much of that mania in the late 1990s was centred around technology stocks. The “dot coms” were going to lead us to a promised land of improved productivity and lower prices. Everyone was excitedly talking about “portals”, “eyeballs”, “stickiness”, “clicks not bricks” and the “new paradigm”.

Mobile (cell) phones were still in the ascendency and the stock prices of handset makers such as market leader Nokia Corporation (NYSE:NOK) were flying high.

Also, by mid-1999 the stock price of software giant Microsoft Corporation (NASDAQ:MSFT) was driven up to a level that hasn’t been matched since, 16 years later.

Basically the stock of any company associated with technology was seen as good…however unlikely the business model…however absent the profits…and however lofty the price.

Investors went crazy to get a piece of the action…Brokers rubbed their hands with glee at the new wave of commissions that were falling into their laps.

Investors went crazy to get a piece of the action. Often they gave up proper jobs to try their luck at day trading via newly available internet broking services. Brokers rubbed their hands with glee at the new wave of commissions that were falling into their laps.

We don’t have that retail investor frenzy these days. Especially in the US, the big buyers of company stocks these days are…drum roll…the companies themselves.

Management teams have been borrowing at low rates to buy back their own stock and drive up its price, instead of investing in growth. As share prices go up it creates an illusion of corporate prosperity. But real prosperity – in the form of growing earnings power – is thin on the ground.

Driving up share prices with buybacks means the management’s own stock and options rise in price, even if profits aren’t growing. They’re in the money even though they haven’t done their job of growing the business. Financial engineering has replaced real engineering…and product development, and marketing and so on.

And much of the time they are overpaying for the stock, which ultimately destroys value for shareholders. Cheap cash is wasted on expensive shares. So in a sense these management teams are looting the companies that they control.

All they had to do was find an investment banker, click their fingers in the vague direction of the compliant investing mob, and the cash rolled in.

Back in the late 1990s the scam was different. In those days the promoters of new tech companies, usually with dubious business plans, raised huge amounts of equity capital. All they had to do was find an investment banker, click their fingers in the vague direction of the compliant investing mob, and the cash rolled in.

Much of that cash was busily frittered away on glitzy launch parties and private jets – until it ran out and the companies went bust. The racket is different these days, but it’s still a racket. Gullible shareholders are the losers.

The biggest tech stock of them all at the moment – in fact the biggest stock of all stocks – is Apple Inc. (NASDAQ:AAPL), which is valued at US$633 billion. It’s basically a re-run of the Nokia story, given that two thirds of sales are from cellphones, albeit supposedly smarter ones than in the ‘90s.Top10softwarecompaniesin1984

Remember: Nokia was the leader in cell phones in the late 1990s and early 2000s and now is out of the business. Also Blackberry (remember those?) also had its revolutionary moment in the sun, but is barely still going. Apple has the potential to go the same way: down if not totally defunct.

And for those tempted to invest in the speculative new technologies of today, it’s worth remembering that Apple’s share price was the same in late 1997 as it was at the time of its IPO in late 1980. It wasn’t always the huge success story that we take for granted today.

Apple survived – just. But over those 17 years there were countless other computing and tech firms that went under. How many of these leading software companies from 1984 have you ever heard of? Only Microsoft is still standing.

 

And a quick look at a few of the more successful tech stocks shows how bumpy the ride can be.

Speculative tech: stock prices since 1991 Blackberry (green), Nokia (yellow), Apple (red), Microsoft (blue)

Specualtive-Text

Aside from Apple, other parts of the tech world are in obvious bubble territory today. One biotech ETF is believed to have a P/E ratio that’s running around 2,000, which is just insane (see here for more). You may as well take a punt on a rank outsider at the horse races. It’s certainly not investment as I understand it.

And social media stocks continue to have prices that rely on a wing and a prayer. Facebook Inc. (NASDAQ:FB) has a P/E of 93 and a market capitalisation (whole company value at current share price)  of US$252 billion.

The big piece of hype this week is that Facebook now has over a billion users. So apparently each one is worth US$252. I use Facebook, and I’m definitely not worth that much. I suspect I’m not alone.

LinkedIn Corp (NYSE:LNKD) and Twitter Inc. (NYSE:TWTR) don’t even have P/Es since they don’t have any earnings, just big losses. But this doesn’t stop these “soc coms” having massive market capitalisations of US$23.4 billion and US$19.2 billion respectively. (See more on bubbly social media stocks here and here.)

So a new generation of tech investors is likely to learn some old lessons. Cash is king, and if companies can’t generate it then they aren’t worth anything.

In this environment of weak commodities, a strong dollar, expensive US stocks and bubbly tech there’s another important thing that’s similar to the late 1990s. Emerging markets are deeply out of favour once more. Hated, downtrodden, ignored.

Using latest figures for the end of July, and taking account of price falls since then, I estimate that the MSCI Emerging Markets index has a price-to-book ratio of just 1.3.

That’s well below the 1.8 average P/B that the index has had since 1995, according to investment bank J.P. Morgan. Put another way the index would have to rise 38% to get back to an average valuation using this measure.

Of course the P/B has been even lower a couple of times in the past, but only for a short time. During the 1997 Asian crisis it very briefly touched 0.9 before recovering strongly. Then it hit 1.25 in late 2000 as all markets fell across the world. In both 2002 and 2008 it was at a similar level to today’s 1.3. All those instances saw emerging market stocks double or more in the following year or two.

In other words, apart from during the Asian crisis, emerging market stocks are kicking around the cheapest levels they’ve seen over the past 20 years. But nothing is happening right now on the scale of the Asian crisis, when many countries went bust.

Of course the commodity exporters, like Brazil and Russia, are suffering from depressed prices. And people are worried about a slowdown in China, rightly or wrongly. But in the absence of a real meltdown the emerging markets look distinctly cheap again.

Emerging markets P/B 1995 to March 2015 (now even lower)

Source: JP Morgan
Source: JP Morgan

Here’s another chart that compares the MSCI Emerging Markets index (orange) with the MSCI USA (green) and MSCI Europe (blue) since 1990, all measured in US dollars.

Source: MSCI
Source: MSCI

Any investors that bought into emerging market stocks during the 1998 or 2002 lows went on to massively outperform the developed markets in the coming years. And that’s right up to the present day, despite poor recent performance.

Here’s that same chart since the later date of 31st August 1998, a little over a year after the 1997 Asian financial crisis started and just after the 1998 Russian crisis had hit.

MSCI-developed
Source: MSCI

Since then emerging markets are up 140% versus 104% in the USA. That’s despite emerging market trading at depressed prices today, and US stocks being expensive again. (Note also how poorly Europe has performed. See here for more on the grim future of Europe.)

So there are definite parallels with the late 1990s. Commodities are weak, the dollar is strong, tech is over-hyped, US stocks are over-priced and emerging markets are deeply out of favour.

Of course there are many differences too. I’m not saying conditions are exactly the same. I’m just pointing out some important parallels.

As I wrote earlier this week, it’s still a little too early to pile into emerging markets. Jitters remain and we could be entering crash season. Best to sit back and watch for a few more weeks or months.

But it pays to remember that things move in cycles. Today’s dancing pony is tomorrow’s dog food. And this week’s mangy, flea-bitten dog is next week’s cherished pedigree.

Welcome back to the late 1990s.

Stay tuned OfWealthers,

Rob Marstrand

robmarstrand@ofwealth.com

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Rob is the founder of OfWealth, a service that aims to explain to private investors, in simple terms, how to maximise their investment success in world markets. Before that he spent 15 years working for investment bank UBS, the world’s largest wealth manager and stock trader with headquarters in Switzerland. During that time he was based in London, Zurich and Hong Kong and worked in many countries, especially throughout Asia. After that he was Chief Investment Strategist for the Bonner & Partners Family Office for four years, a project set up by Agora founder Bill Bonner that focuses on successful inter-generational wealth transfer and long term investment. Rob has lived in Buenos Aires, Argentina for the past eight years, which is the perfect place to learn about financial crises.