Tech Bubble Redux?

The past few weeks have confirmed just how far we have come with respect to the ever present undulation between fear and greed. Compare, for example, the Egypt effect with what the specter of Greece did last spring. Whereas the latter transfixed investors for weeks, the violence and seemingly imminent revolution in a much larger, more strategically important country (could a country be less important, to anyone but its creditors, than what Greece has become?) was assiduously ignored until a day or so before the crisis reached crescendo, and was down the memory hole over the course of a weekend. Similarly, China raises interest rates, an event which a year or so ago reverberated through global markets. This time, despite the Market being 5+ months into the kind of updraft that simply begs for some kind of correction, US equity markets barely take notice.

As noted in the last Musings, I have raised a bit of cash, so as to be able to take advantage of whatever Market correction inevitably comes our way. Based on the appetite for equities demonstrated in recent weeks, we can expect this “waiting for a pullback” to be a somewhat frustrating exercise. It usually is. It reminds us that one of the reasons “the rich get richer...” is that there is tremendous advantage in not having to have all of one’s capital hard at work all the time to have enough for necessities and contingencies. A little something can be held in reserve for bargain-priced opportunity. At some point, the Market will pull back enough for us to be able to feel good (as good as one can feel during sell-off, anyway) about loading up on a few stocks we don’t own enough of, but waiting for such an opportunity is no fun at all when the clamor for returns greater than bank yields or from sterile, inscrutable assets like gold is as fervent as it has been.

That Tech, or at least certain elements of that now hoary segment, is leading the way in this new Bull Market should not be surprising, given that its been over a decade since they took away the punchbowl (and started noticing what was actually in the punch) from its last party, especially given how prosperous so many of the Tech companies have actually been in the mean time. I would not go so far as to predict that it will get 1999 stupid again, but there is no real reason that it could not, or at least post a reasonable facsimile of that once-in-a-generation bacchanalia. What matters is that not only has whatever pain investors experienced after that music stopped had time to fade from memory, but a whole fresh crop of suckers with no such experience has appeared. Barring a disruptor on the order of “the Chinese economy finally falls out of bed”, investor enthusiasm around mobile internet and its key enablers should experience a multiyear run that culminates in what can only be described as greed addled frenzy. Having lived through and chronicled the last one, I have gleaned a few principles that need to be kept in mind if an investor wants to make the most of this situation without getting so caught up that they end up giving it all back.

The first thing I would remind investors, or at least value investors, is to not let cynicism get the better of you. Mass delusion, frenzy and despond are more or less hardwired manifestations of the human condition. These episodes are like the weather. There’s just not much upside in wishing it were otherwise. Short stocks at your own peril, especially itty-bitty floats of companies that are so flawed as to seemingly not deserve to exist. Being “right” in such judgements gets very expensive and even debilitating if you are too early in times like these. I managed to make some pretty good money shorting the last one in 2000, but only because I took a hiatus (from short selling) of at least three years after some painful lessons early on. There is substance lurking beneath the hype that in at least a few cases will come to fruition, like AMZN eventually did, and its dangerous to bet against when the crowd is agog with lust for capital gains. (Those looking to invest in the hot sub-segments, the cloud or storage or app companies that are going to “change everything”, should consider that AMZN owners were treated to a -95% retreat from its 1999 peak price, waited until 2003 for a GAAP profit, 2005 for positive net worth and 2009 for recovery to the 1999 price. And this was an exemplar, one of very few dot com darlings that actually survived.)

Yes, there is a company in that mix that is going to “change everything”, at least until some other entity opens up a can of “change” on them. (The once vaunted WinTel duopoly, as sweet a spot for an enterprise to be in as you could ask for, and for how many years?, but not so much lately, comes to mind.) Observing and handicapping change is important to the extent that there is a speculative element to one’s investment approach, and there is at least a bit of speculation in practically every equity investor’s game plan. It’s only a question of degree. Much discussion goes on as to whether what is going on around mobile compute is evolutionary or revolutionary change. It would be most accurate to say that its all pretty much evolutionary, but with occasional discontinuities in the rate of change when advances in key enabling technologies synch up. There is nothing new about data de-duplication, for example. Its something that IT professionals have worked at in various ways for a couple of decades already. Occasionally there is a breakthrough in the software or an element or hardware that makes it easier, but it has been about as pervasive and plodding as a typical commodity producer looking to keep its costs competitive. Cloud computing is really just more of the same trend of IT trying to handle burgeoning data flow with something less than burgeoning hardware that has gone on since the inception of the PC, an exercise of plodding desperation given the degree to which “burgeoning” is no hyperbole at all. Tablet computers are hardly new, either. It’s just that in this go-around, the bandwidth was finally robust enough in enough places and the gestures were catchy enough to get the attention of the fashion conscious segment of the consumer market.

And speaking of fashion, another thing that has become apparent since I got interested in Tech is that the IT world is, in its way, as rife with fashion and hype as the rag companies I used to follow. The blather that emanates around “cloud computing” is not all coming from the investment bankers, though those fine folks have certainly noticed that (as they like to say) “the ducks are (again) quacking” and are doing their best to cobble up a feast. An awful lot of what gets press-released from the companies and the remora-like flacks who subsist in their wakes is hype of a sort that takes a while to be sufficiently anesthetized from. There is a level of blarney around Silicon Valley, and it goes up at times like these, that takes some getting used to. Fashion, as manifested in the what some people will pay up for in order to be seen with, also applies to consumer gadgets. We see outsized buzz apportioned to that consumer segment that finds itself reflexively buying whatever the “cool kids at Apple” tell them to buy. (F.D. I own a Mac and an iPod, and rather like them.) There has always been a fast moving market in those folks who invert that Roman wisdom that “it is more important to Be than to Seem”. Such markets are not unimportant and often lucrative, but ultimately, success with the other 90% or so of the buying public will come down to rendering a compelling value: the same functionality at a lower price, better functionality at the same price, or better function at a lower price.

One final reflection on how the nascent Web 2.0 Bubble might resemble the Tech Bubble of 1996-99 has to do with the extent to which this one will, as the last one did from April 1998 on, “suck all the air out of the room” for seemingly everything else (i.e., the Real Economy as opposed to New Economy stocks). Its already happening, albeit in a more benign way, within Tech. There can be little doubt that some of the money feeding the frenzy in favored sectors is coming from “Old Tech”. The aforementioned WinTel certainly comes to mind here. These were “no brainers”, feel good stocks for many, many years, until seemingly everyone owned them. Both INTC and MSFT still have enviable business positions, in the moment and with respect to the “mobile compute” boom that is upon us, but they also have huge shareholder bases that are frustrated with nothing to show (stock price wise as opposed to business performance wise) for more than a decade. So they are using them as sources of funds. Fortunately, this has been going on for several years. At some point, the share base will be reconstituted and perhaps shrunken by repurchase, and the price can revert to something more in line with the underlying commercial reality.

While MSFT, INTC and other discredited but still powerful companies represent good value, and a decent risk adjusted (no need to wonder if you picked THE winner as opposed to one of numerous also-rans) way to participate in the Mobile Compute bonanza, the most egregiously mispriced segment of the Tech world, in my estimation, is hard disk storage (HDD). It is simply not the dreadful business it once was, when some ninety HDD makers went at it. Its down to just five, two of which have two-thirds of the market. (The other three are less agile captives of Asian CE makers.) The technology is still advancing, but not in the disruptive “big step-change” way that did in so many of the erstwhile competitors. There has been much talk, for years already, of solid state drives (SSD) taking share (see aforementioned role of hype) but the best they seem to be able to come up with is that SSD will only slow (as opposed to reverse, a critical distinction in a volume sensitive, capital intensive business with impregnable barriers to entry) the growth in HDD volumes for the next several years at least. The performance of Western Digital (WDC) in particular, by any measure other than stock price over the past ten years (growth, returns, cash accumulation, whatever) is not the stuff of single-digit, or even discount, multiples. So here is my prediction: when we look back on the “mobile internet driven Bull Market of 2009-??, some of the biggest share price gains will be from stocks in the companies that advance the now fifty year old technology that is HDD. It will be partly about earnings growth, perhaps partly about capital shrink or merger, and quite a bit about reversion of the disparity between presently wretched Price Reality and the actual value of these enterprises.