What Worked In The Tech Bubble

Bubble headlines distract from unseen opportunities — Great investments exist in any market environment — Patient, contrarian investing works in the end.

 VIEW AS PDF

WHAT WORKED DURING THE TECH BUBBLE

“Let us accustom ourselves, then, to avoid judging of things by what is seen only, but to judge of them by that which is not seen.”

— Frédéric Bastiat, “That Which is Seen, and That Which is Not Seen”, July 1850

When discussing investment bubbles we tend to focus on the losses experienced by late-arriving investors. For effect, peak-to-trough drawdowns are highlighted, despite the reality that few investors buy at the absolute peak and sell at the absolute bottom.

In addition, bubbles are often concentrated in specific securities or sectors: tulips, railroads, and internet stocks come to mind. More recently, investors have been stung by drawdowns in cryptocurrencies, NFTs, and SPACs. But experiencing truly devastating losses would have required investors to concentrate their portfolios in these areas.

Drastic losses are obvious, frightening, and “seen” by everyone, but, outside of widespread economic depressions, these investment wipeouts impact only a small portion of the market.

Even in recessions, there are plenty of “unseen” opportunities that serve investors well. In fact, with bubbles capturing so much mindshare, their formation often creates highly attractive investment opportunities outside of the mania of the day.

Tech Bubble Review

The Nasdaq 100 dropped 46% from December 31, 1998, through December 31, 2002; this loss is more palatable than the often-cited 80% decline from the March 2000 peak, although still devastating for investors concentrated in tech stocks.

During this four-year period, the Nasdaq 100 soared, at one point up over 150%, before crashing. This rapid ascent contributed to the lasting fame of the tech bubble, as much of this rise occurred within a five-month period from late 1999 to early 2000.

These jaw-dropping statistics are what is seen, and much talked about, from the tech bubble. Now to the unseen.

Unseen Indices

Numerous indices performed well through the internet bubble. The Dow Jones Industrial Average dropped only 9% from year-end 1998 to year-end 2002, avoiding the worst of the tech decline.

Similarly, investors could have protected their capital by diversifying into small caps, with the Russell 2000 declining only 9% as well.

For true contrarian investors, the Russell 2000 Value index increased by 20%, providing strong absolute returns and outperforming the Nasdaq 100 by nearly 70 percentage points.

Diversified investors who resisted the urge to go all-in on internet stocks likely protected much of their capital, drastically outperforming the much-discussed peak-to-trough declines of the Nasdaq.

Unseen Sectors

Sector dispersion is another common phenomenon during investment manias. Although simply avoiding technology stocks did not result in positive investment returns, investing in sectors ignored by the market presented an opportunity.

From 1999 to 2002, numerous sectors protected capital, while the Information Technology and Telecom sectors dropped 73% and 65%, respectively.^* 

Investors in Consumer Staples saw positive returns through the downturn. In addition, allocating to Health Care, Financials, or Energy, all boring industries without the excitement of the internet, would have resulted in less than 10% losses.

Unseen Investments

Finally, the tech bubble presented an outstanding opportunity for stock picking. With so much attention focused on internet names, other high quality businesses were left behind.

Conservative investors could have generated 25-30% returns from 1998-2002 by investing in Walmart, Bank of America, or Johnson & Johnson. By simply avoiding the FOMO of internet stocks, these investors grew their capital instead of watching it get cut in half.

Small cap investors could have discovered Ross Stores, Gilead Sciences, or Stryker. Ross had a few hundred stores in the U.S. and a clear plan to expand its concept across the country. Gilead launched its first major HIV drug in late 2001. Stryker had acquired Pfizer’s orthopedic division and was building its portfolio of reconstructive implants. Shares of these businesses more than doubled from 1998 to 2002.

Even well selected S&P 500 tech stocks provided opportunity. Oracle continued to grow its database product and Adobe rolled out its creative software. While these businesses both soared and dove from their peaks, both investments generated exceptional returns through the bust.

Seeing the Unseen

Nearly any economic environment, outside of a 1929- or 2009-style depression, offers attractive opportunities for patient investors. All that is needed is the discipline to select unappreciated, undervalued, and unseen investments.

*GICS sectors were created in 1999; exact sector returns for 1998 are not available. Sector return numbers are estimates.