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With Investor Phil Town

What is a Tech Bubble? And How to Tell if We’re in One

The stock market has had a mind of its own recently. Companies are currently so overpriced, and we’ve seen every unconventional market behavior in the book including shorting, squeezes, meme stocks, and all kinds of other crazy events. It’s almost impossible to tell what might come next. 

Many people think we’re in a tech bubble, and it’s not particularly difficult to see why. 

It’s no secret that tech stocks make up a large portion of the S&P 500 and the NASDAQ today, or that the pandemic has sent stock prices skyrocketing as the demand for work-from-home technology and food delivery apps has soared. 

We are ever-dependent on technology, but has that left us hyping up tech companies beyond what they’re actually worth? 

Likely. 

In fact, we’ve recently seen a significant dip in the market, especially in the tech sector. So, are we in a tech bubble? Has the bubble burst? And what does it all mean for you? 

Let’s dig in.

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What is a Tech Bubble?

Technology companies receive a lot of attention from both investors and the media. Particularly in the modern era when so much of our life is conducted online through our phones, streaming services on TV, and even software in our cars. 

Thus, tech stocks receive a lot of attention and money from both institutional investors and novice Robinhood users alike. This drives stock prices higher, which contributes to even more attention and investment until prices are so inflated that this sector of companies seems to rule the world. 

However, they’re usually not all that they’re cracked up to be, and when investors realize this, a surge of sell orders on tech shares ends up causing a significant dip in the market.  

In a nutshell, a tech bubble is defined by the sharp rise and fall of tech stocks due to consumer excitement and overvaluation that leave them with nowhere to go but down. 

Looking Back at the Dot-Com Bubble

This isn’t the first time we’ve seen a surge in tech stocks. If you’re over the age of 40, you have been around long enough to remember the tech bubble of the late ‘90s and the market crash that ensued. This bubble ended up bursting in the year 2000, after many of the new and exciting internet companies that people were thrilled to throw their money at went bankrupt. 

What exactly happened? 

During this time, the internet was relatively new and extremely exciting. Many investors poured their entire life savings into trendy tech stocks whose business models were unchartered and who lacked a clear path to future profits. 

While some companies survived the crash, many did not. Sadly, when these companies failed to adapt to market or regulatory changes, those who invested in them saw the value of their shares dwindle to zero. 

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What We Learned From the Dot-Com Bubble

As with any market crash throughout history, there are things we can learn from the burst of the dot-com bubble, and these lessons are quite pertinent today. 

The biggest lesson is the importance of carefully evaluating a company you plan to own, no matter how great it might seem at the moment. If investors had considered the 4Ms—the key components that ensure a company is a sound investment—before investing in many of the tech companies surfacing at that time, they likely would have avoided the burst altogether. 

The same is true today. 

Just because a company is garnering a lot of press or Reddit attention, doesn’t mean it’s worth investing in. Every business, whether it’s a tech company or not, requires careful evaluation before earning your investment. 

You should know the ins and outs of how it functions and profits, who its management is and how they make decisions, how it is influenced by certain economic conditions and global events, and what price you can buy it at to guarantee a great return. 

This may sound like a lot, but when you take the time to research companies before purchasing a piece of them, you can negate much of the risk of investing. Plus, you won’t experience the downfall of your dollars if a bubble occurs and bursts. 

Are We in a Tech Bubble Now? 

So, are we experiencing something similar to the dot-com bubble today? The answer is almost certainly yes. 

Given the market conditions we’re currently experiencing, I think it is extremely likely that we are in a massive tech bubble that is about to pop…if it hasn’t already started to, as we’ve seen the tech sector take a significant dip already.

As we look at this tech bubble, here are some of the factors we’re considering that might signal a market at its peak… 

The COVID-19 Pandemic

The COVID-19 pandemic has played an obvious role in the increase in stock prices of tech companies over the course of the last year. Although we initially saw a crash back in March of 2020, the stock market quickly rebounded and has continued to take unprecedented twists and turns since. 

Investing during a pandemic has been uncharted territory, but it has also proved that if you follow the same principles for finding great companies during COVID, you can experience success.

With the rise of remote work and online connections, the pandemic has certainly accelerated the growth of certain tech companies. The question is now, can those companies sustain that growth? 

For example, how will companies like ZOOM fare after the pandemic is over and people return to work? Realistically, they won’t experience the same demand they did during this unprecedented season. And the signs of this are already beginning to show.

The Effects of Inflation 

Inflation is another factor that has a big impact on the stock market. Inflation is largely influenced by economic policies made by the Federal Reserve and funding projects from the executive office. 

Look back at when the president decided to send Americans stimulus checks, the Federal Reserve printed the money to do so. While this helped keep Americans on their feet during a trying time, it also put much more money into circulation, thus decreasing the value of the dollar. 

The more money the Federal Reserve Bank prints, the more they contribute to rising costs. Hence, inflation. 

In 2020, alone, the Fed printed 36% of all US dollars. We have already begun to see how this has started to contribute to inflation. And, with the way things are going, it is bound to continue to increase.   

Impact of inflation

The Rise of Interest Rates

Now, interest rates go hand in hand with inflation, because if the Federal Reserve thinks the rate of inflation is rising, they will raise interest rates to help control it. 

How does this influence the stock market? 

Well, as interest rates rise, it makes it more expensive for companies to borrow money, which means they have less capital to fund new projects that will contribute to growth. Tech stocks that often depend on large amounts of capital inflows before they become profitable will be affected by this rise. 

Less capital equals less growth, which often translates to a lower valuation and thus, poorer performance in the stock market. While the Fed still hasn’t begun to raise interest rates, it’s only a matter of time, and when they do, you can expect this bubble to burst. 

What to Do When the Tech Bubble Pops

Most things get the name “bubble” when referring to the market only after the “bubble” pops because, well, that’s what they do. 

So, will the tech bubble burst? 

Given the uncertain outcomes of the pandemic, the rising inflation rate, and the incline in interest rates that are sure to follow, not to mention the incredibly high valuations of tech stocks we’re currently seeing, the burst of this tech bubble we’re in is imminent. 

Eventually, the stock prices will drop. So, what should you do when it does?

Investing in a pandemic

A tech bubble burst doesn’t mean that many of the tech stocks won’t recover, though. The strongest companies will survive and continue to produce great returns for their investors. So the time to buy them is when that bubble pops and they go on sale

Make sure you have cash on hand so you’re ready to buy when the time is right. As always, do your research and be prepared with your watchlist. Some of the wonderful companies you have been eyeing for a while will go on sale when the tech bubble bursts.

So, if you have done your research, you will know the right ones to buy and be able to get them at the right price with a margin of safety. 

Time to Find Wonderful Companies

As part of your research, be on the lookout for companies that have enough cash on hand and little debt to ensure they can make it through a dip, and that won’t be affected by future inflation, but instead will be able to grow with inflation. 

Remember, be patient. The time will come when the bubble bursts and finding the best stocks to invest in now, so you’re prepared when it does, is how you make money while you wait.