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Dotcom deja vu: warning signs before next crash 

Aug 06. 2017
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By   SPECIAL TO THE NATION 

AS FAANG (Facebook, Apple, Amazon, Netflix and Google) stocks keep making new highs, it seems like we are travelling back to the dotcom era when any listed companies related to the internet or advanced technology attracted tremendous capital inflows and their stocks kept soaring higher.

The dotcom euphoria could not last forever, and many of these stocks faced a deep plunge in value – just like what happened in previous bubbles in financial market history.

If the equity market is screaming similarities with the dotcom period, what can we learn from history and how can we prepare for the worst in order to protect our hard-earned capital?

Prior to figuring out any strategy to prevent a severe loss in portfolio value should a market meltdown arise, let’s examine the similarities between the dotcom bubble and the current market situation.

One could easily see that there are three outstanding likenesses: the Fed’s tightening cycle; a flattening yields curve; and robust performance in technology-related stocks

Back 1999-200, the Fed raised the federal fund rate four times, from 4.75 per cent to 5.75 per cent. Did the number of rate hikes ring a bell? Yes, four was exactly how many times the Fed raised the interest rate after the post-great financial crisis of 2008 – from 0.25 per cent to 1.25 per cent.

With rising uncertainty in US economic outlook and subdued inflation, many market participants have started to wonder if the US economy is on the verge of a recession or economic slowdown. So far, the evidence has revealed itself in a flattening US treasury yields curve. 

This brings us to the second similarity between now and the period before the dotcom bust. Interestingly, during the dotcom era, the yields curve’s steepness gradually flattened as well, since the smart money had growing concerns about the bubbling stock market. 

Now, a decreasing slope of the yields curve is also a theme for many investors, mostly due to disbelief in reflationary pressure – especially when the US government has failed to push any pro-growth agenda.

The last resemblance between the dotcom era and now can be seen in the global equity market. By looking at both bull runs on the equity market, we could find that the performance of the technology stock indices was astoundingly strong. The Nasdaq composite jumped at least 90 per cent between the first Fed rate hike in 1999 and the fourth hike in 2000. The outperformance of risky assets was even more astonishing when one looks at the other technology indices such as the MSCI Asia ex Japan information technology (MXASJIT) index, which soared roughly 107 per cent during the same period.

Since late-2015, the story hasn’t been much different from the dotcom time, as the MXASJIT index has gained about 60 per cent since the first Fed hike of this cycle. Over the same period, the Nasdaq composite only went up by 25 per cent – however this was a result of the recent health-care stocks beat up.

Though it is impossible to foretell when this bull market will turn into a bear market, we should learn from the past financial calamities – especially the dotcom bubble, due to these similarities – to protect our investments. 

The question is: what can investors do to survive an upcoming deep market correction?

Views expressed in this article are those of the author and not necessarily of TMB Bank or its executives. 

First part of a two-part series |POON PANICHPIBOOL is Economic Specialist at TMB Analytics. He can be reached at Poon.Pan@tmbbank.com

 

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