There is a historical pattern of overinvestment in a first bubble leading up to a crash, followed by a second wave which exploits the now-cheap capital assets and actually does fairly well. You can see this in railroads, real estate, telecommunications infrastructure at various points from telegraph to telephones to fiber, and arguably financial capital markets themselves when new investment vehicles open up.
The point of this is that second-wave investments often look a lot like the first, but with much higher-quality real capital associated with them (eg, gold mines that actually produce at least some gold, vs. the gold-exploration firms of the first wave).
Combine it with basically zero-opportunity-cost money dumped into the financial sector by the fed and it's a recipe for perhaps-inflated valuations, but mostly in the context of investments in actual assets. You might see very low returns for an indeterminate time, but large negative returns are something else.
TLDR: There's a difference between banks buying and selling fundamentally profitable financial investments to each other at inflated nominal values, and sinking large amounts of money into unprofitable real assets.
How many people does it take to start a ski resort? Three. One to buy all the land, go broke, and declare bankruptcy. The second to do all the paperwork, permits, go broke, and declare bankruptcy. Then a third to buy all that and start a ski resort.
As soon as I read the first ten words I started thinking telecom. Much of our current boom is based on the wasteful infrastructure spending of the last bubble.
Usually a good indication of an actual bubble is that nobody believes it's a bubble. When you have the average man on the street thinking this is the new wave and we're all guaranteed to get rich off software companies, then it may be a bubble. Right now it seems like there's a healthy skepticism in the general public.
The economy has been so crappy that people are crossing their fingers and pretending a bubble doesn't exist even though deep down they know it does. After all, it can't get any worse, right? It's like people who have terminal cancer and are otherwise rational skeptics who decide to pursue alternative therapy. Hope, even false hope, is a powerful thing.
Because the economy is so crappy money is flowing into the one area which still has the (perceived) possibility of a significant positive return on investment.
Unfortunately, like markets tend to do, that's been raising the prices/valuations to levels at which few investors will be actually able to get market beating returns on investment.
If I'm right then this market is indeed experiencing an artificially high demand, but the dynamics make it more likely to simply have it dry up eventually rather than having it pop (like a bubble would.)
"A recent Bloomberg survey of Wall Street investors, analysts and traders who use the company’s financial data terminals found that the majority thought Internet and social media stocks were at or near unsustainable levels.
Roughly half said that the bubble was here or soon would be."
It's not really significant, because there aren't many people involved in this bubble. If the startup scene in SV gets cut in half, it's going to hurt locally, but the broader economy won't go into recession. In addition, should some VC funds go bust, it won't trickle much to the average consumer.
The problem with the dotcom bubble and the housing bubble was that laypeople were very much involved (everything was IPOing and everyone was jumping in), and so were their retirement funds and their debt levels. The US economy lives and dies by the consumer.
> It's not really significant, because there aren't many people involved in this bubble. If the startup scene in SV gets cut in half, it's going to hurt locally, but the broader economy won't go into recession. In addition, should some VC funds go bust, it won't trickle much to the average consumer.
You're missing the plot. There are numerous asset bubbles today and they are all being fueled by the same source (the central banks).
It is unlikely (although possible) that the current "tech bubble" will pop on its own. It is more likely that it will pop at roughly the same time as the others when the massive experiment in monetary policy we have seen since 2008 comes to an end. The bursting of many of these asset bubbles will have a devastating impact on the broader economy, and the fact that numerous bubbles are bursting at the same time will only exacerbate the situation.
Timing, of course, is uncertain. The day of reckoning could come tomorrow, or it could come a decade from now. The disturbing thing is that the longer this goes on, the more painful the impact.
I hear this claimed again and again, and I've never understood what people are saying. Why will a reduction in money printing cause a stock market crash? And why doesn't the intense money printing today cause a large amount of inflation? None of these two things make sense to me.
Share prices are based on the last price paid. If there's a constant supply of new money from "nowhere", it's easy to keep bidding up the prices of existing assets.
Put another way: the effect of $80 billion / month doesn't have to be $80 billion / month. It can be the effect of using that $80 billion to drive up the prices of existing assets. If I have cheap money and feel like Example Company Inc is worth bidding from $100 to $500, even if I only buy a few percent of the company, I just quintupled its headline value.
That's the argument. I think it's a little simplistic that the "only" reason for the current bubble is US Federal Reserve policy, insofar as bubbles can form without an inflationary monetary policy. But it's not totally unreasonable to assume that it's playing a contributory role. It can certainly make any bubble a more bigger and frothier bubble.
Whether federal reserve policy is blowing up a software bubble has more to do with who gets the money than with the fact that money is being printed.
Hyperinflation's been around the corner for 5 years now. Obviously the doomsayers (and classical economics) are failing to account for some massive deflationary pressures. If current policy gets us <1% inflation, it stands to reason that normal policy would have us in a deflationary state. Hyperinflation is not about to show up and wreck everything.
But as far as who gets the money.. there's certainly the possibility that capital's being allocated in a suboptimal way due to banks getting the money, as opposed to I dunno, public works programs or handing out $100 bills on the street. (IMO fed policy-makers would be fine with the latter two, but they're less politically palatable in some sick way)
Australia's Federal Government did a one-off $900 handout at the start of the GFC. Later studies showed that it was mostly diverted into paying off credit cards, so it didn't actually have the stimulatory effect that was hoped for.
The problem with the blunt instruments of monetary and fiscal policy is ... they're blunt. And usually come with nasty side-effects. Again, in Australia, the Reserve Bank has been steadily pushing interest rates down to try and get our dollar to fall. They're not having much luck in that department, but they have kicked up a surge in Sydney house prices due to record low mortgage rates.
As for there being a software bubble, I think there is such a thing, separately from any effects of US monetary policy. But I also expect that monetary policy is making it more spectacular. The S&P 500 has been surging ahead of other economic indicators, that's usually a sign that there's a lot of money swirling around looking for somewhere to go.
I definitely agree that there's money swirling around looking for somewhere to go.
We're kind of in no-mans-land for political economy punditry on this one -- nobody knows how the hell to explain the current situation, Econ 101 is totally insufficient.
I'm inclined to think that with the unemployment rate and stagnant wages for the bottom 80% of income earners, coupled with all this extra money swirling around, we need to find a way to connect the two, ramp up demand, get a positive cycle started that way. No idea how to do that, though.
As far as whether there's a software bubble.. I dunno. Maybe there's a VC bubble, because of the aforementioned money, but I think twitter would be getting investment while being unprofitable in most economies that have a facebook to point at.
>Why will a reduction in money printing cause a stock market crash?
Because asset prices aren't being supported by underlying capital accumulation from the sale of goods to meet demand. They're being supported by flooding the capital market in cheap money. The underlying "real economy" of nonfinancial goods and services is pretty much still in recession, and the labor markets and aggregate demand with it.
A bursting of the current tech bubble will be fairly significant for those of us in the tech industry, e.g. many of the users of this site.
When the dot-com bubble burst investors didn't just get scared away from companies with weak fundamentals - they got scared away from all types of tech investments. So it won't just be the groupons and zyngas that get burned - the amazons and apples and googles will drop in value too.
And those questionably sustainable startups are soaking up a lot of the supply of young techies, keeping salaries high. The seller's market we tech employees currently enjoy won't last for ever.
Still, markets can remain irrational for a very long time under the right conditions. Or perhaps Snapchat really is the future of communications and I'm just too old to recognize it.
Compared to the dot-com era, companies are raising negligible sums. Maybe you can get $2M for a failure, but you're not seeing pre-traction companies raising $300M. Similarly, every IPO we've seen has been of a company which actually has real value. Facebook is already profitable and Twitter is seeing real revenue.
Even the Snapchats of the world have a lot more going for them than their dot-com cousins: people actually use them.
Is McDonald's really worth $100 billion?? It's some guys making hamburgers!
Valuation is based on a whole host of things including revenue, brand recognition, distribution, customer acquisition costs, customer retention rates, switching costs, growth, etc. You could start a Dropbox competitor and have none of those. The business matters far more in valuing the company than how hard it is to replicate the product. It's much easier to make a hamburger as well as McDonald's than it is to make a business as good as theirs.
McDonalds' revenue in 2012 was US $27 billion. Dropbox's was US $200 million. Certainly there's a lot of potential upside in Dropbox, but it's risky too - their business could easily be disrupted by unexpected developments. McDonald's is pretty much safe as houses.
So yes, I think the question stands - is Dropbox really worth 10% of McDonalds?
You can have a web-site plus their hard hard drives for less than $1 million.
Now, try also getting millions of users, tens (hundrends?) of thousands of paying customers, tons of possitive reviews from both major outlets and happy users, Jeff Bezos investing in your company (IIRC), hundends of third party apps offering integration with your service, etc...
Oh, and the technology to do what you do, and do it AT SCALE. And also the history of having met and solved tons of technological (OS/use case/etc) obstacles in the process of building your app, now in it's Nth year.
I mean, what are you on about? Just a website and some hard drives?
Dropbox is probably one of the more sustainable companies mentioned in the article, since they have a very large amount of actual paying users and revenue.
That and the fact that Pinterest is actually exploring how to gain revenue. They've used Skimlinks (http://skimlinks.com/) before to affiliate the content posted on their site. Probably the best idea out there.
Many financial assets are currently at high valuations compared to fundamental indicators and historical ratios. Due to QE and other unusual post-crisis effects there is simply a huge amount of excess capital in the financial markets. Combine that with low-to-negative real interest rates and it is no surprise that a lot of risky seem overvalued (benchmarked to a world with normal money supply and interest rates).
i think the main difference between now and 1999 is that software really is eating the world. 1999 jumped the gun a little bit. but to me there is no upper limit on just how much work software will be able to do for us going forward, now that the infrastructure is in place to support such a transformation. i think there is a lot of hype, but unlike in 1999, when nobody was sure what the value of the internet actually was, it's based on a central fact: the world of the future will be operated by software.
i'm sure there will be booms and busts but i don't think they will be nearly as severe as in 1999.
Furthermore, I'd say the world of software has diversified greatly beyond what we had in 1999. Social media companies with no revenue may experience a bubble pop, but I don't see that being an issue for VCs, whose portfolio contains completely different kinds of tech companies like Uber or Liquid Robotics for example.
I think this is one of the best points. The environment is different.
Why are "apps" companies taking off? Because Google, Microsoft, and Apple are actively selling billions of phones to customers. These customers, in turn, fuel the app market. This is not a "bubble". These are consumers buying real products with real value, making companies real money. This isn't a "potential" type of deal, this is happening and fuels some of the biggest companies.
Why are companies like Google making money through advertising and why are other sites using Google's ad system to make a ton of cash too? Because there's a market for it. People visit the internet, they see ads, they click on them and buy. Products and money gets exchanged. Amazon is in on the deal too because, guess what? People buy products from their site.
Now, why is Snapchat and Pinterest so highly valued when they make 0 revenue (albeit Pinterest having tried the affiliate game for a short amount of time)? Because of the existing markets and companies that can profit on their products. Pinterest is already trying out revenue models, how? Affiliate programs where people click on pretty pictures of something or the other, buy the product and pinterest makes cash. Nothing magical about it. Snapchat will be harder to monetize but could "easily" be purchased and used as yet another product for a company to capitalize on and get someone trapped in their ecosystem. See facebook about instagram. Same deal.
I'm not as familiar with the dot-com bubble as others but seeing revenue happening because people are moving to more of an online world rather than an offline one makes sense. People buying products, purchasing subscriptions to entertainment, buying subscriptions to useful utilities (eg. dropbox) makes sense. Ad companies fueling online advertising to get people to buy shit or subscribe, makes sense. Companies that profit on having users and engaging those users while advertising for companies that sell products, makes sense.
The amount of borrowed money on the stock market as a percentage of GDP recently reached an all time high. And with institutional interest rates as low as they are, money is cheap, and it's flowing into tech. In fact, one could make the case that the entire global economy is being propped up by central banks.
And there's no denying that the price of snapchat is bat shit insane. Plus look at facebook, running out of ideas, losing touch with the youth, desperately trying to buy up burgeoning competition. This is characteristic of the sector as a whole.
Ultimately, the old rules always apply -- companies without revenue, that continue to spend at a deficit, cannot go on forever, it's as simple as that in the long run. So, given that there are a lot of companies that fit that, either they must figure out how to monitize effectively or they'll eventually fail. I'm not sure where the controversy is in that. Now, the second issue is whether the valuations are correct -- and, again, I'd say that the old economic rules still apply. It doesn't matter what your company does, valuation comes from how much it can grow real equity through real earnings. Anything else is just overzealous investment.
So, yes, there's a bubble. But the more interesting question is, how much will it hurt when it bursts or deflates? That's the better question, IMHO, and that's one I don't see being quite so cut and dried.
Or maybe the values are inflated because we're in the middle of a currency war with all the central banks in the world trying to devalue their currency harder than the competition?
The point of this is that second-wave investments often look a lot like the first, but with much higher-quality real capital associated with them (eg, gold mines that actually produce at least some gold, vs. the gold-exploration firms of the first wave).
Combine it with basically zero-opportunity-cost money dumped into the financial sector by the fed and it's a recipe for perhaps-inflated valuations, but mostly in the context of investments in actual assets. You might see very low returns for an indeterminate time, but large negative returns are something else.
TLDR: There's a difference between banks buying and selling fundamentally profitable financial investments to each other at inflated nominal values, and sinking large amounts of money into unprofitable real assets.