Ask HN: Is the Tech Bubble Crashing?
I’m looking in awe of the total carnage in a lot of tech stocks over the past year or so, and accelerating in the last few weeks/months.
While the FAANGs have so far held up ok (ex-Netflix), there’s a lot of small or mid cap tech stocks that are down 50% or more in just a few weeks. ARKK and related ETFs are down more than 50% since Feb 2021 highs.
I understand a lot of this is due to the Fed’s new hawkish stance which disproportionately impacts high p/e stocks like many public tech companies due to rising rates and asset purchase tapering.
But how long is this trend away from tech going to last?
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[ 4.0 ms ] story [ 121 ms ] threadFor example, Cloudflare ($NET). More than 58% down from its all time high, even before the Fed announcing their interest rate hikes. In the long term, it will possibly reach its all time high again, but needs to correct first before that. Some other stocks many never reach their highs again.
Now it should be easy to agree that this was indeed an obvious sell signal [0] despite many at the time telling you to buy.
[0] https://news.ycombinator.com/item?id=29355360
But "Crashing" is point of view. I.e. if you short the market (a seller), the market is actually up. I.e. you should not try to time the market but time the DIRECTION of the market.
Also, the Fed is not hawkish, if it could it would not raise rate.
Gambling should be illegal.
“I think it would be very difficult to overvalue that”
Most people I speak with feel that the market, and tech especially, is overvalued. Put differently, the expectations of returns is so far in the future that they’d rather hold their money back for a nearer term bet.
Consider the company that is regularly booking earnings, while another is spending all their revenue (and more) on investing for growth. The first will result in a lower PE, while the second will have a much higher PE all other things equal. Most growth companies are more similar to the latter, rarely booking earnings, and instead often raising capital or taking on debt to continue growth.
For growth companies, Free Cash Flow analysis and understanding the balance sheet is typically a better way to understand performance and assess value.
Let's say you have two companies: 'Established' that makes $100 million/year, and 'Growth' that will make $200 million / year in 10 years, but $0 / year today.
Let's say both of these facts are 100% certain and that all market participants agree. Finally, we assume all market participants work off of a 20 year investment cycle just to keep things simple.
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With 0% inflation, both companies are equal over the 20 year lifecycle.
However, with 5%/year inflation, the established company comes out far ahead.
The $200 million made in year 10 by Growth is only with $122 million (year 1 dollars).
So you can see, future money is less valuable in an inflationary environment. In contrast, the $100 million made by Established is worth $160 million in year 10.
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Once we account for inflation, the growth strategy fails. Alternatively, growth strategy only works in low inflation environments.
In high inflation environments, established sources of money and established real estate / factories is better. The growth company promises to buy a factory in the future, but we all know inflation is making that factory more and more expensive, and it's future promise of future money is getting less valuable.
I guess ultimately you're assuming interest rates or staying with inflation, but they don't and it's actually interest that's the bigger factor.
In 2014, Tesla raised a ton of money from the stock market to build the Model 3 factory / giga factory.
Over the next few years, in a low inflation and low interest rate environment, the investors won. The factory was built, and years later the Model 3 was released to the public.
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How would things have changed if large inflation occurred in 2015 or 2016? The factory would have cost 5% or 15% more than expected, and the money raised in 2014 may have not been sufficient.
The 2014 dollars raised are used to buy a factory in 2015 or 2016. That's just how companies work.
If inflation changes the price of the factory years later, that absolutely affects the investors. The 2014 understanding of factory prices would be wrong, revised later and everyone would make less money in the long run.
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EDIT: With less effective money (due to increased factory prices), the Growth company will either have to raise more money (ie: dilute the shares and split future earnings with more investors), or build a smaller factory (ie: lowering the amount of future production).
Either way, the investors would have lost our on future earnings, roughly coinciding with inflation (ie: how much more the factory cost)
The real change you see is with interest rates rising, the cost of capital also rises (fewer big investors investing borrowed money or using leverage) and safe alternatives become much more readily available (if a bond or savings account pays money it is safe and you earn a return - as opposed to all the 0% real returns you had in the past).
This suggestion only tilts the argument into my favor.
Apple makes 190 million iphones/year or so. In an inflationary environment, Apple will still make 190 million iphones and probably still sell them all.
Those 190 million iPhones will cost 7% more to make, but also sell at 7% higher prices. So we see that Apples expected profits will rise by 7% or whatever inflation is.
But the factory loans that Apple bought 5 or 10 years ago are in 2010 dollars and will remain so. We can see that inflation helps established companies regardless.
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It is the growth companies who don't own factories yet, who are raising money today that get hurt by inflation.
> It is the growth companies who don't own factories yet, who are raising money today that get hurt by inflation.
Yep. They, too, compete with opportunities like bonds and savings account.
> But the factory loans that Apple bought 5 or 10 years ago are in 2010 dollars and will remain so.
Lots of companies have issued bonds at very good interest rates. They're not mostly for factories. Apple's been borrowing money at rock-bottom rates to do share buybacks, because the money's basically-free.
> It is the growth companies who don't own factories yet, who are raising money today that get hurt by inflation.
So how many growth stocks are investing big into building massive manufacturing operations, Elon? I can think of around one, but certainly not Apple.
Even things like Backblaze buy up hard drives and data centers to sell services to us in the future.
Buying up thing to make more money later is the age old strategy.
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Changing the balance of Growth vs Establishment is the biggest effect of inflation (and interest rates).
Established companies like Intel can rely upon older factories if the new factory turns out to be a bad bet. Growth companies are 100% all in on future factories (or future equipment, like Backblaze).
> So you can see, future money is less valuable in an inflationary environment. In contrast, the $100 million made by Established is worth $160 million in year 10.
I'm a little confused by this. If $200 million was projected as the future earnings of the growth company, isn't it likely that that will also change with inflation? In other words, if we think today that Growth will make $200 million in 10 years, based on inputs X, Y, and Z, then aren't X, Y, and Z also affected by inflation in the future, and so Growth would be affected downstream by this? E.g. maybe part of the $200 million projection is that X will spend 20% of funds on Growth. But now we multiply that 20% by the effects of inflation -- (1.05)^10 -- and X has more to spend, and so Growth makes more as well, proportional to the increase from inflation.
I guess what I'm getting at is that inflation affects everything. In your example, it's as if Growth has some static 10-year-out contract for $200 million, which feels a little odd.
Inflation can be viewed as a change in supply /demand ratios. So car chips supply goes down, demand for cars is constant, price goes up.
Lumber Mills closed during lockdown, supply of lumber constrained, demand goes up, price goes up.
But the price of lumber, and cars, are not really linked.
Yes, some commodities have knock-on effects - food and energy being prime examples - when oil goes up that tends to impact large areas of the economy because large areas have oil in their supply chain.
So, whole average inflation is a useful benchmark number, it may, or may not, impact a companies future earnings, or more precisely, it may not impact earnings and costs in the same way.
Growth doesn't own anything yet, they have to build that factory before they get their profits.
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The $1 billion factory will itself be worth $1.07 billion after 7% inflation, and the $1.14 the year after that (after another 7% inflation).
What analysis study is the price of factories and associated costs. A growth company (like Rivian) is buying new factories and on the path to make 200,000 trucks / year. There are discussions about whether or not that will happen, but you can see that the price of those trucks (and the factory equipment to make those trucks) is going to vary by inflation.
> I would expect that any business strategist worth their salt would account for inflation in their projections
Yes, they do. But when expected inflation __changes__, those effects are calculated to cause a change in prices today.
The price of the old factories don't change, they were already bought long ago, and are at worst in the form of a bond (ie: based off of old money from 2014 or whenever the bank gave them that money). The price of future factories goes up.
The FAANG behemoths on the other hand have ad based revenue that isn't going to dip - at least from this aspect of the macroeconomic environment. Other things will crater that, if those things are successful on the public policy side.
FAANG traders likely will take lower price:equity ratios so the shares will trade lower.
Sure, there's a downturn and it's related to COVID and the US printing money, but overall there's not that much of a downturn. Will it continue? Who knows. Is it tech or is it more of a general downturn in the market? It's definitely not exclusive to tech.
Having said that, the Fed does also boost or squelch the ability of banks to lend to companies/their ability to increase performance not backed by actual profits and expenses (P/E). If you're an investor you look at P/E and the value of products. If you are a trader you look at stock price/performance almost exclusively. Traders trade both directions at all times (hedging long positions). Investors only play long positions. VCs seek to empower companies with potential.
1) inflation continues to rise, keeping the pressure on the Fed to raise interest rates. This being so, entities like retirement funds that must have some yield, now have non-risky options to get it. They rotate out of tech stocks, which are generally considered higher risk, higher yield.
2) crash in stocks causes the Fed to lose courage, they don't raise interest rates after all. Now Treasury bills and other low-risk options are too low yield, not even keeping up with inflation. Whether they are confident in the tech stocks or not, entities that must find yield somewhere will invest in them because "lower-risk" options are no longer options, as they are guaranteed to lose money on an inflation-adjusted scale. This means tech stocks go back up, even if nobody much believes in them.
Whether or not the Fed (and European Central Bank and other similar entities worldwide) are more afraid of inflation or of stock prices crashing, is not a thing I can tell you. But those are, I think, the two scenarios.
On the other hand usually if the US sells off, so does europe, so probably this time would be no different.
While if US sells off, so does Europe. However as the market recovers you would think Europe would return to previous 'reasonable valuations' faster than US would return to their current greater overvaluation levels?
Personally I've avoided US markets for some time for more p/e realistic markets like Australia (my country) and Europe in part for above reasoning.
The one I am watching is Asia, as SE Asia has the growth potential over western nations I feel but its not quite time but I would like to get more across Asian based ETF's in the future.
...IM no expert so shovel full of salt and all that :)
Not 20 years ago, it was rare to be employed in tech outside of one of the major hubs. Today, some small towns couldn't even exist without Amazon. When I was a kid, if you worked at Wal-Mart, you probably screwed up. Today you can have a high paying SWE job for Walmart. Microsoft is now one of the largest video game developers in the world, and Netflix and Google have essentially killed the entire business of cable TV for anyone under 40. Apple has the most successful and widely adopted consumer electronic device on the market, and without it, people would lose their collective minds.
Everything is now tech.
So, there's a third, middle option: the fed actually walks the tight-rope and the amount of inflation is acceptable and stocks take a couple of years to regain their losses. This is the most likely option. That could mean raising rates as planned, raising fewer times than planned, or not raising at all.
If that works, then great, everyone's stocks will recover over time and they'll be happy, and inflation won't get too out of control. Keep in mind that some inflation is considered "good" in this system and has been going on pretty consistently since we started central banking.
If that doesn't work, then the fed has so much authority to take direct action in the markets, they have essentially infinite capital to deploy to move markets in any direction they'd like. Using this authority is a risk, but they have been successfully doing some type of "quantitative easing" since 2010.
There's a lot more creativity to go in engineering financial markets before they'd simply give up the game and accept loss of control of the currency, because it would invalidate the idea of central banks and be incredibly disruptive to society.
With most of congress filled with wealthy elites, if it comes down to a crisis like in 2008, everyone will cooperate to preserve their elite status, which is exactly what happened then. It's essentially mutually assured destruction between governments and business if they can't work out a deal, which is what they were able to do. They'll do it again if needed.
Also, as long as things change slowly, people generally don't notice, or don't do anything about it because it's become normalized. There's $1.7T in US student loan debt and that's barely crossing the threshold for people being upset enough to take political action about it.
Those that have crazy valuations but no clear sign of turning enough profit to remotely justify that valuation are going to have a rough few years ahead. There’s a lot that will need to be washed out of the system before things reset and the cycle starts again.
The "Growth Bubble" will burst, and those companies will shrink back to valuations that are not completely detached from reality (which in some cases will be 0).
FAANGs will still be money printing machines, the same as they've been for the last decade - no big worry there, just a slight correction (10-20%).
1) the drop starts because the fed starts to withdraw liquidity...
2) the market will trade sideways while the fed unwinds its balance sheet...
3) Once the market drops sufficiently far (30%+), or a recession is induced, the fed will blink and inject liquidity again ...
4) Causing the next wave of growth.
4) Causing the next wave of asset price inflation
When the policies swing back, so will the market.
I believe advertising has reached a peak and has been declining for a while and we’re finally seeing the downstream effects of that.
Infinite growth is not possible and I believe we’re way past the peak and are now seeing a readjustment of the market.
The available time market for advertising is probably already reached; attempts to get people to watch more ads in a day have gotten higher levels of pushback (adblock etc.), and thus limited success. This means, in order to achieve growth, advertisers have to either charge more, or increase market share.
Up until now, it's been Google and Facebook taking market share from traditional media, which has more or less imploded, so there's not much more room for growth in that way. They can only charge more for advertising if they are currently charging significantly less than it's worth, which is probably not true. So, even if advertising works at current prices (I am skeptical it always does), that doesn't mean that the revenue from it can keep growing at the rate of growth that Google and Facebook are used to.
I'd rather own an OIL company at 3x FCF than Netflix or anything like that.
Nobody knows. It’s a non-answer, but the only truthful one.