Here's the evidence that we're in a new tech bubble, heading for a crash, just like the dot com bust of 1999.
Interest rates are effectively at 0%.
Before we get into specific evidence that the tech sector is inflated, it's worth restating the macro-economic context: Interest rates are basically at zero and have been for some time. When borrowers are paying close to zero interest on loans, that makes money cheap to get. This chart shows the Fed's target rate for interest since 1970.
People with money generally have a choice: save it in interest-paying, risk-free bank accounts or invest it in riskier assets that may pay more money over time. When interest is at zero, virtually any other kind of investment is likely to pay more because the risk-free alternative is so lousy. So investment asset bubbles get created. Stocks tend to go up.
The stock market is at a peak, which is exactly what you'd expect in a zero-interest environment.
We've had five years of solid growth in stocks. People who have invested in stocks in the last five years now feel very, very rich. What could possibly go wrong?
The market moves up and down, in cycles, as this chart of the S&P 500 stocks shows.
We're due for a downturn.
(BlackRock CEO Laurence D. Fink, whose company manages $4.1 trillion in assets, agrees that the Federal Reserve is creating “bubble-like markets.”)
In the tech sector specifically, there has been a recent run-up in deal prices.
This chart was published by PriceWaterhouseCoopers, which tracks merger and acquisition activity in the tech sector.
It notes that "software deal volume tripled that of the second quarter."
The driving force?
High stock prices and corporate giants who are rich with cash and need to invest it, PwC says.
It's not just tech asset prices that are high. Salaries are high, too.While unemployment generally may be high, in the tech sector it is very low.
Matt Allen, a tech recruiter at Vertical Move, told me recently:
Want an example?
Twitter svp/technology Chris Fry got a $10 million pay packet. He only joined the company last year.Mike Schroepfer, got $24.4 million in 2011, Reuters noted:
It's not just wages that are expensive. Company valuations are rising too.Supercell, the game company, just raised $1.5 billion in new funding at a valuation of $3 billion. Supercell has real revenue — $178 million in Q1 alone. But you've got to question the logic of the people doing the deal: Investor Masayoshi Son, the founder of Softbank, believes he has a "300-year vision" of the future.
Even the CEO of Supercell thought he was joking when he first heard about it.
Companies with broken business models are highly valued.Fab.com, the design retailer, recently raised $165 million in new investment this year, for a total of $336 million in all venture funding. It did so despite laying off 440 employees after deciding that the flash sales model — in which customers are asked to suddenly purchase a daily deal — doesn't work. It was Fab's second business model "pivot" — the company started life as a gay community site. We're not saying Fab is going out of business. We're saying that Fab's backers have been fabulously generous.
Companies without meaningful revenue are highly valued.Pinterest just raised $225 million in new investment funding, a stake that values the company at $3.8 billion. That valuation is fictional, of course. It's based on the notion that the company could be sold or go public at that price. That price is 10 times what investors have actually plowed into the company. To be clear, Pinterest is showing every sign of turning into a great company. It has already solidified a role for itself as a key referrer of online retail and e-commerce traffic.
But still, this is a company that currently is rumored to make only between $9 million and $45 million in revenue.
Companies with no revenue at all are highly valued.Snapchat is rumored to be raising a new round of funding that values the company at $3.6 billion on paper. This company has zero revenues.
And it's not easy to see how it might make money: It's defining product deletes itself after just a few seconds.
The last time we saw companies with no revenue receiving high valuations from investors was right before the 1999/2000 dot com crash.
Yahoo is again paying top dollar for companies with no meaningful revenue, just like it did in 1999.Tumblr is actually an excellent product with 50 million users. But for Yahoo to make money on this deal Tumblr will have to generate profits after sales of greater than $1.1 billion.
My sources tell me that with the right adtech, Tumblr could generate several hundred million in ad sales revenue over the years. But they don't believe Yahoo will ever get its money back on the deal.
This is significant because Yahoo does not have a good track record when it comes to buying in a bubble. In 1999, right before the last tech crash, it bought for $5.9 billion in stock and GeoCities for $3.57 billion. Neither business had meaningful revenue and both have since been shuttered.
Companies are making dumb decisions: This startup chose beef jerky over a 401 (k) plan.New Yorker recently wrote:
Companies are making dumb decisions (part 2): There are more Facebook ad agencies than regular ad agencies.Facebook has about 300 so-called Preferred Marketing Developers. They all do one of just four things: Place ads on Facebook, manage Facebook pages for companies, provide social media analytics, and create marketing apps for Facebook. They are basically ad agencies, in the sense that advertising clients hire them to promote their brands via Facebook.
But there are more Facebook PMDs than there are major ad agencies in the U.S., even though the non-Facebook ad business is many times the size of Facebook. Not all of these companies will survive, and a few have recently realized that there is not enough money to support them all. Even Facebook has moved to cull the herd.
Serious investors are beginning to suspect a tech bubble has formed, and that a crash is coming.
Art Cashin, the the director of floor operations for UBS Financial Services, has been around the block. He recently worried that he he was seeing things that reminded him of 1999:
Andreessen Horowitz is pulling up the ladder.Groupon and Zynga. Now it is saying it will no longer invest in early stage consumer-oriented startups. They're done.
Andreessen is interested more in later stage and business-to-business-oriented companies. Companies with actual prospects of real revenue, in other words.
This, arguably, is the kind of "flight to quality" you often see when asset prices and stocks start falling. What does Andreessen know that we don't?
One of the most legendary tech investors, Tim Draper, thinks we're at the end of the curve.
Timothy Draper is the founder of Draper Fisher Jurvetson, a venture capital outfit that has invested in dozens of tech startups. He's been around since the days when Hotmail was the big new thing. He recently told The New Yorker that he believed tech venture capital may have reached the top of its cycle:
Let's hope he's wrong.