Tech bubble concerns
Fears that another tech bubble is about to burst was discussed by Dr Linda Yueh and US journalist Janet Alvarez on Sirius XM Business Radio, a business radio network based in New York.
With tech shares down, in some cases by more than 50% this year, while startups are suffering confidence-withering down rounds, there are reasons for concerns argues Dr Yueh, who is Adjunct Professor of Economics at London Business School.
While we have been witnessing a tech revolution happening due to AI, tech valuations have been falling, with big companies like Klarna and Stripe seeing their valuations drop.
Are valuations set to fall further?
“I think they are,” says Dr Yueh. “Big startups over the past few months have seen declines in values of 85%, and we have even seen a Unicorn fail, so some could argue that we are seeing echoes of what happened during the dot.com bubble in 2000. As Mark Twain once said, ‘History never repeats itself, but it does often rhyme’.”
Yueh says that we should be thoughtful about what is happening in this sector as we are seeing valuations that are significantly lower than what they were at their height. While we could see the tech sector begin to normalise, on current trends we ought to monitor the situation very carefully.
Dr Yueh says the tech market has grown thanks to exceptional conditions. Following a decade of very cheap interest rates and cheap money. “It is not just the banks, but also the shadow banks, and that includes private equity and also investors who are not officially regulated as banks. All of these bodies, have put money into very promising start-ups, especially in the areas that are increasingly transformative such as AI, e-commerce. There does some to be some pick up in those companies that are in the AI space, or, for example, in such areas as autonomous vehicles”.
One could see down rounds becoming more of the norm, with valuations reflecting more what companies are worth, and not driven by the amount of cheap money that is available.
Another underlying cause for the tech bubble seemingly being about to burst is the overvaluation of the industry. “We could see that there could be a shake-out from the sector just as we saw in the past dot.com bubble, with Amazon and Ebay surviving while others failed. As Warren Buffet has said in the past, ‘only when the tide goes out do you discover who's been swimming naked’. So down rounds could become normal just as with public companies”.
Dr Yueh says that one of the biggest concerns in the market overall is how long will interest rates remain higher, with a focus on the impact on both the shadow banking system and public markets.
“We know that the Fed is possible due to increase rates again before the end of the year, taking the benchmark interest rate, perhaps later this month, to a 5.25%-5.5% range. One of the Members of the Federal Reserve Board of Governors Christopher Waller has backed a rise this month, which is against what the markets were expecting. Futures markets were expecting one more interest rate rise from the Fed, but are expecting the Fed to start cutting rates over the course of the next year, down to 3.8 % by November of next year. On that basis, markets have been rising on the expectation that this tightening cycle is going to end soon. So if you look at the Nasdaq, it is up 33% and the S&P 500 is up 16.5% year-to-date, so there is this belief that interest rates will come down and that we won’t see this stubborn inflationary period last for too much longer.”
Therefore, the cost of capital and cost of borrowing will start to come down, says Yueh. “The expectation is that rates will fall next year, but if inflation proves to be more persistent and if Governor Waller is right that we won’t see a rapid decrease in interest rates, that could put a lot of pressure on heavily leveraged creditors in the public and private spheres.“
Dr Yueh adds that the key indicators to look for are, first of all, core inflation. “This excludes food and energy prices and has slowed more gradually sitting at 4.8%, which is far above the 2% target. So if core inflation remains high, and then depending on what happens to the labour market, which is another indicator of how resilient the US economy is, these two factor will impact on market sentiment. Therefore, I would watch core inflation and employment payrolls”.
The S&P 500 is the most concentrated it has been since the 1970s, says Yueh, with seven of the biggest companies on that index, such as Apple, Microsoft, Alphabet Inc., and Amazon gaining between 40 to 180% valuation in the first half of this year, with the rest of the companies in that index remaining flat.
“It is very rare to get this kind of dominance in big tech companies, and just five of those represent a quarter of the entire market cap of the whole index. It does seem that the bigger companies that are sitting on cash, and if the rates continue to be high I would expect to see this kind of dominance to continue. Private markets are lagging public markets and will be lagging them by about 18 months. Therefore, although the public market recovery has been strong this year, private markets remain weak and will not see a recovery until next year, driven eventually by borrowing costs coming down, which will see a private investment more possible. We could see on current projections we could see that conditions remain volatile for markets and the trend very much depends on the cost of capital”.
Dr Linda Yueh CBE’s new book, The Great Crashes: Lessons from Global Meltdowns and How to Prevent Them, covers the history of financial crashes, offering an accessible and insightful overview of modern financial crises, incorporating both historical detail and thoughtful analysis.
