Listed tech stocks seem to be deflating, although how long that’s going to go on for is anyone’s guess. But there’s enough evidence that you can, if you so wish, argue that we’re at the end of a bubble in tech valuations. Marc Andreessen* doesn’t agree which is why he’s still pumping money into the system. Noam Scheiber over at the New Republic has an interesting take on the whole argument, one that I find myself largely agreeing with.
Sure, there can be bubbles, we know that very well. But we tend to think of them as being when the entire society collectively loses its mind and starts day-trading Pets.com. Or, the incident that told Joe Kennedy to sell out of the 1929 market, when his shoe shine boy wanted to discuss which stocks he should be purchasing. Scheiber picks up on a point that Robert Shiller has been making for some time now (and in part won him a share of the Nobel) which I’ve mentioned here before, which is that it doesn’t have to be the entire society, just the people involved in a particular area. This is also something that James Surowieki described in the Wisdom of Crowds. If, imagine, valuations of upstart tech companies were not being driven by the valuations of all on the public markets then we don’t need all of those involved in public markets to be suffering from groupthink. We only need those involved in the actual pricing of pre-IPO tech stocks to be so suffering and we’ll get prices that will be out of whack with reality.
This, of course, works on both the up and the downside. But the argument here is that it’s working on the upside as companies delay their IPOs, leaving the valuations of the larger startups still subject to the valuations of a small group, the sort of VCs that provide late stage VC capital.
A market dominated by insiders may even exacerbate the self-delusion. When most tech stocks trade on public exchanges like the NASDAQ or the New York Stock Exchange, skeptical investors at least have the opportunity to bet against them by selling short, which can have a disciplining effect. But when firms stay private, only insiders like venture capitalists and other tech executives have a chance to invest, and there is no way to bet against them.3 “I had lengthy discussions with [the French bank] Societe Generale for six months about how to short,” says Bob Rice, a New York-based money manager, who ultimately threw up his hands. “It’s a terrible problem that you can’t short [tech startups].”
If there is a bubble in tech stocks then that’s where it’s happening goes the argument.
Of course, we can also all note that while a bubble might lead to a misallocation of capital, we can also get some pretty cool things coming out of investment bubbles. There were both canal and railway manias and many investors lost a great deal: but we did get canals and railways out of it all. The dotcom boom left us with Google and Amazon among others. Sure, we’d prefer to have those successes and not the disasters but that might not be quite how it works as John Cassidy points out here.
The idea being that not just there can be good coming from the investment misallocation that is a bubble, but that to get certain technologies off the ground that misallocation is actually necessary. And it’s an idea that I’ve a certain sympathy with. The mobile phone revolution over here in Europe is certainly of vast benefit to the society as a whole but very few of the airtime providers are covering even their cost of capital, let along making real economic profits. That could mean we’ve got a misallocation: or it might be that competition isn’t enabling the service providers to capture enough of the value-add to create those economic profits. We’re fine with that last of course: it’s the larger societal benefit that we want, profit is only something we grudgingly allow as a way to encourage it. As long as we do get it who cares about the investors?
However, sympathy or not I’m not sure that it’s entirely true. For I can certainly think of large technological changes that happened without an investing bubble. The electrification of industry, as an example, didn’t have any speculative mania at all connected with it. And it was most certainly a huge technological step, from the steam engine to the dynamo and electric motor. Quite apart from anything else it entirely changed how you designed a factory, from one engine running many machines to each machine having their own engine. But there, that change happened over many decades. Which I think might be the clue to whether or not the bubble is necessary: Time. For something that produces near immediate change then perhaps the wave of capital that speculation will provide is necessary. If the change is going to happen gradually over a generation or two, perhaps not.
I know, apologies, I haven’t told you whether tech stock prices are in a bubble or not. The reason for that being that neither I nor anyone else knows. We’ll only know when we can look back into the past and thus know what has already happened. We can only play our various hands and see what results.
*Marc Andreessen is a personal investor in Pando
[Photo by Petr Dosek]