The Rules: Tech Market Cycles

The tech market washes out about every eight years or so.  The broad market, which is a more robust beast, washes out far less frequently.  My question: are these variants of the same phenomenon?

I wrote this back in early 2003.  I can now answer my own question: No.

I’ve looked at this question many times, and debated the answer, but there are a few things that have made me decide “No.”

  • Sectors often move independently of the market as a whole, particularly growthy sectors that lose their growth.
  • The big moves of the market as a whole have usually been correlated with credit crises, which are part of the financial sector, not the tech sector.
  • The tech sector grows more slowly as a whole now, and hasn’t washed out for a while.
  • The financial sector fails because of financial leverage, the firms are too levered, and take too much credit risk.  The tech sector fails because market players bid up the prices of stock assuming permanently high rates of growth.  These are fundamentally different reasons for over-valuation, because most tech stocks have little debt.

Credit crises lead to big overall declines in market values, particularly with financial stocks, but affecting all other stocks, because when credit conditions are tight, things slow for all firms.

When tech stocks are overbid, it is more of a local mania where market players overestimate the degree of growth the sector can achieve.  There is little collateral damage to the market.  A seeming exception to this is 2000-2002, where the market went down with tech, but financials were less affected. In that drawdown, tight Fed policy drew everything down, and tech more than everything else.  Remember the NASDAQ Composite (INDEXNASDAQ:.IXIC) over  5000?  Still hasn’t returned there, while the Dow, S&P 500, and Russell 2000 have hit new highs.

Here’s the summary: financial stress tends to be pervasive, affecting everything.  Stress from growth expectations that disappoint tend to be sector-specific, and don’t drag down the market as a whole.

And so the answer to my question that I asked 10+ years ago is “no.”

By David Merkel, CFA of Aleph Blog



About the Author

David Merkel
David J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately. From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, I was a leading commentator at the investment website RealMoney.com. Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that. Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog. I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.