Lessons from the Dotcom Bubble

I’ve repeatedly been saying here that the obverse side of every mania is a crash.

Sovereign Man’s Simon Black shares the lessons of the dot.com mania-crash cycle and their relevance today. (bold mine)

If someone mentions the Dotcom Bubble, Pets.com is easily the first thing to come to mind.

The online pet product store failed hard and it failed fast. In just 268 days, the company went from IPO to liquidation, managing to lose $300 million in the process.

Yet it had looked good to investors, at least for a while.

Pets.com spent exorbitant amounts of money on advertising; its sock-puppet mascot was the 90s equivalent of a viral phenomenon.

But while the company spent hand over fist on advertising, Pets.com’s was losing money on every sale because they priced their inventory at BELOW cost. Duh.

Pets.com went public on the NASDAQ in February 2000 (right as the bubble burst) at $11 per share.

The stock peaked at $14, valuing the company at over $300 million. Not bad for a company whose business model virtually assured they would lose money.

But reality set in just nine months later. The company’s stock fell over 99%, and management announced they would liquidate.

Now… we could criticize Pets.com management all day long for a ridiculous business model. But bear in mind, investors bought the story.

People believed that profits didn’t matter. And back then it was typical for loss-making companies to be valued at hundreds of millions of dollars.

Have things really changed since then?

Facebook bought revenueless Instagram for $1 billion in 2012. Snapchat, the revenueless sexting app, is now valued at $10 billion.

There are so many examples like this. And like 1999, no one seems to care.

Silicon Valley investors keep writing huge checks. “Likes” are the new valuation metric. Not profits.

Several top Silicon Valley insiders are now hoisting the red flag saying enough is enough.

Bill Gurley, one of the most successful venture capitalists in the world, told the Wall Street Journal last week that “Silicon Valley as a whole . . . is taking on an excessive amount of risk right now. Unprecedented since ’99.”

Fred Wilson of Union Square Ventures echoed this sentiment on his blog, railing against the widely accepted model that it’s acceptable for companies to be “[b]urning cash. Losing money. Emphasis on the losing.”

George Zachary of Charles River Ventures wrote, “It reminds me of 2000, when investment capital was flooding into startups and flooded a lot of marginal companies. If 2000 was a bubble factor of 10, we are at an 8 to 9 in my opinion right now.”

As with all bubbles, it all comes down to there being too much money in the system.

Capital is far too cheap, and that pushes people into making risky and foolish decisions.

When you’re guaranteed to lose money on a tax-adjusted, inflation-adjusted basis by holding your savings in a bank account, almost anything else looks like a better alternative.

That’s why stocks keep pushing higher, why junk bonds yield a pitiful 5%, and why bankrupt governments can borrow at 0%.

Jared Flieser of Matrix Partners in Palo Alto summed it up when he told the Wall Street Journal, “You can’t afford to sit on the bench.”

In other words, money managers view NOT investing as losing, even if investing means taking huge risks.

It’s an abominable position to be in. If you do nothing, you lose. If you do anything, you take on huge risks.

This, of course, is thanks to a monetary system in which a tiny central banking elite conjures trillions of dollars out of thin air in its sole discretion.

History tells us that this party eventually stops, creating all sorts of unpleasant financial carnage. This has happened so many times before, and it would be arrogant to presume that this time is any different.

But it begs the question: what does one do? Is it worth trying to ride the bubble and try to get out before it all collapses?

Read the rest here

In a manic phase, unfortunately neither profits nor history matters at all.

During the dotcom bubble, monetization of “eyeballs” rationalized overvalued and mispriced stocks.

The modern day equivalent has been to concoct the “likes” business model. Both have been predicated on illusionary profits from perceived network effects. So they end up with fantastic valuations like the above.

In the Philippines, the justification has been about G-R-O-W-T-H (from the Ponzi growth model).

In reality the common denominator of every mania has been about the delusional “this time is different”.

The Mania phase I previously described:

Manias, which operate around the principle of the “greater fool”, signify a self-reinforcing process.

Rising prices induce more punts which lead to even higher prices as the momentum escalates. Suckers draw in more patsies into a mindless wild and frenetic chase to scalp for marginal “yields” and or from the psychological fear of missing out and or from peer pressures all predicated on the belief of the eternity of a risk-free one way trade. The intensifying hysteria will continue to be egged on by the beneficiaries from such invisible political redistribution both in public and private sectors, supported by bubble ‘expert’ apologists and media cronies.

Therefore, recklessness will compound on the accrued recklessness. Again this isn’t just a problem of overvaluations (from which the BSP’s perspective has been anchored) which merely is a symptom, instead this represents deepening signs of intensive misallocations of capital expressed through the massive contortion of prices and the disproportionate distribution of resources on a few sectors at the expense of the others that which has mostly been financed by debt accumulation, thereby elevating risks of financial instability or an economic meltdown. The BSP’s increasing use of communications with sanitized “alarm bells” signify on such emerging risks

And like typical Ponzi schemes, the manic process goes on until the ‘greater fools’ run out, or that every possible ‘fool’ has already been “IN” (crowded trade), or that borrowing costs has reached intolerable limits to expose on foolhardy speculative activities

Don't you see? Stocks can only rise FOREVER!