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As investors observe significant technological advancements during the time of COVID, some may be reminded of the dot-com tech bubble in the late 90s. Marcello Montanari, Vice President & Senior Portfolio Manager, North American Equities, compares the tech companies of the past and present. He also shares an overall market perspective on rising valuations within the sector. [15 minutes, 22 seconds] (Recorded December 8, 2020)


Hello and welcome to the Download. I’m your host, Dave Richardson, and I’m really happy to be joined by… — In fact, I’m going to start off with an apology to Marcello Montanari, who leads a great team of people working mostly on the technology sector in North American equity markets, part of our North American equity team. So, Marcello, sorry to you and to the listeners, we should have had you on much earlier in this series because you’re one of the real experts in this space. And it’s obviously an area of interest to investors right now. So welcome to the podcast.

Thanks for having me, Dave.

So hopefully we’re going to get you on, on a semi-regular basis going forward. But perhaps the best way to start when we look at this sector, which has really been a leader in markets all around the world, not just in North America, but a lot of investors look at technology stocks and the sector overall right now. And for those of us who were around in the late 90s and just at the turn of the millennium, this feels a little bit like that period for technology stocks. Should people be thinking that way or are we in a different spot now?

I get this question quite a bit. And I think the best way to approach it is to look at it from a couple of different perspectives. So first, let me set the stage up for that period in 1998 to 2000. A lot of this job involves pattern recognition and we use a lot of mental frameworks to help us understand the world. And I just want to remind everybody that the lead up to the tech bubble and the tech implosion was a very special time. We had the convergence of two major technological events at the same time. Basically, that was the Internet emerging as a consumer product or platform, not just for consumers, but for businesses as well, and then, wireless. Wireless really came into its own in that period. And one of the mental frameworks that we use is one that was coined by Michael Mauboussin, actually back in the middle of the bubble, and he called it «fill and kill». What it was is, this observation from biology that when you have a brand new ecosystem, you have species — or speciation, I think it was called — that comes in to fill in the ecosystem. And we’ve seen this in multiple waves over history, whether it was railroads, canals, automobiles, the oil age, etc. And so what happens in these «fill and kill» situations, species come in to fill up this new ecosystem. There’s another economist named Carlotta Pérez who’s actually studied these periods. And whenever you have these «fill and kill» periods, you get these speculative bubbles because people are not very discerning about what they’re buying. It’s just like, oh, my God, the Internet’s going to be huge. I need to be there. I’m going to buy Webvan, or Kana, there’s so many names that came out in that period of time and they didn’t really have any business model to begin with. They were all concept stocks. So that’s kind of setting the stage. We were in a period that was really ripe for a speculative bubble along two dimensions, which was the Internet and wireless. And they were crossing over and it touched so much of IT because you needed all the IT infrastructure to help build this out. From my perspective — because I was there, like the second perspective, I was actually at the epicenter of this —, now I’m going to talk about the companies themselves as a group. For sure, there are elements of the tech market that are pretty frothy right now, but on balance, especially when we look at the broader benchmark’s world — I’m talking about the S&P500 and stuff like that —, the broader benchmarks tend to have the bigger names and they’re not as prone to some of the speculation you see in the out-of-benchmark names, some of the Fastly and those type of companies, which seem to get a lot of airplay, but they’re not representative of what’s happening within the benchmark. But anyway, like I said, on balance, the period is very different. Back then, if you recall, since you were there as well, all of it was completely off the charts; anything to do with the Internet, anything to do with Internet infrastructure, with wireless, even companies that were making leather holsters for handsets were trading at 30 times revenues. It was just crazy. Everything was basically off the charts. And just like we’ve had some pretty exciting IPOs that have come out recently, like Snowflake, Palantir, which have had these kind of moonshot performances after that, I’m sure that you remember back then just about every IPO was doing what Snowflake just did. We had 400 of them and it was just crazy. But like I said, back then, most of those new IPOs were concept stocks. They had questionable business models, they had questionable revenue models. We didn’t really know what they were. They were valued on stuff like eyeballs, page hits, multiples of capital, multiples of plants and equipment, price per engineer, price per Ph.D. — I could go on. So that’s what they were being valued on. And a lot of these companies were engaged in some nefarious activity; they were bartering business with each other, they were exchanging assets and recognizing the exchanges like revenues, and anything that they could do to supplement the story. And importantly, a lot of these companies were asset heavy and they were feeding off the exuberance of the market to raise capital. And that capital was being redeployed back into the tech markets to buy gear, computers, networking gear, you name it. So there was this virtual circle of money fed by this exuberant speculative bubble and everything just went up to the roof. But everything was dependent, the linchpin was the market itself. As long as it was giving capital to these guys, the machine was working, until it didn’t. Suddenly it seized up. And that’s when everything fell apart. I was going to use a colorful word, but I’m probably not allowed. So in contrast, today’s companies are asset light. They rely increasingly on AWS, Azure and Google Cloud to supply their underlying infrastructure. Today’s tech stocks, even the recent IPOs, are much more seasoned. They’re coming to market later than they did back then by a long shot. They have real business models. They have real revenue models. They have exceptional returns or you can actually see the path to their returns. And on a lot of these markets are «the winner take most», if not «the winner take all» marketplaces, which really kind of can help fuel a story, as you can imagine.

As you’re talking, this is a walk down memory lane for the period in the 1990’s when wherever you bumped into someone, you got a crazy stock tip and, and it was a wild time I’m sure for many of the people listening. It’ll bring back memories of when they were in that place. But you were talking about now; different, better business models, real businesses, and so carry on.

It’s funny, you’re making me do a Segway here, but I remember Peter Lynch said, when do you know that you’re near a market top? And his answer was: when he goes to parties and the doctors are telling him what to buy.


So, coming full circle here. Maybe the thing that really makes this technology stand out more these days is there’s this kind of «as a service» model; software as a service, communications as a service, etc. And what that’s done is, because you don’t have to buy a gigantic upfront license to actually get access to technology, you just pay for it on a monthly basis, that has expanded the addressable market for all of these technologies that are delivered in that manner. So what this has allowed is for the diffusion of technology from the biggest companies all the way down to the smallest companies. And it’s also facilitated the ability to trial something. If it works, that’s great. If it doesn’t, well, that’s fine as well. And that’s just the way it is. And again, coming back to some of the mental models we use, what this represents when you think about it, is a reduction in friction. And whenever you can reduce friction in a transaction, that’s usually a good thing for revenues. And so we’re seeing that. I think I’ve demonstrated or explained the differences between the companies that are here versus back then. And then I guess the other way to think about it is from the overall market perspective. Rob and I have been using the study that came out from Bernstein, this quantitative study that they recently did, I think it was at the end of September, where they mapped out a whole bunch of things, which was very interesting. But what they did demonstrate was that although valuations have clearly risen, we are still well below what we were seeing in the tech bubble. Way below. When you think about valuations, this is another thing about the environment today; for a lot of valuations, some of the rise can be attributed to a drop in interest rates, which are considerably lower today versus where they were then. On top of that, back then, they were starting to rise. And as you know, growth stocks, tech stocks in particular are long-dated assets. And what we know from long-dated or long-duration assets is when interest rates drop, they’re the ones that are going to move the most. And so we have seen that. But you have that support from interest rates and so if the Fed, the Federal Reserve, signals that it’s going to be lower for longer, it’s likely to drive valuations higher. So that can help explain a little bit of the valuation rise. And then, on another point, lower rates is making it considerably harder for long-duration money. When you’re thinking pension plans and endowments, it’s getting harder and harder for those guys to meet their return requirements. You’ve got to think that there’s going to be an asset mix shift, as fixed income money gets shifted over to dividend stocks and growth stocks in particular. So I think the combination of interest rates dropping has two impacts. The first one, on the fact that long-duration assets will react to that. And then the fact that you get this asset mix shift. And then the other thing from that Bernstein study that was interesting was that for the three years going into the peak, the Nasdaq back then rose 70%. And if you look at the situation right now, we’re in the high 20s. It’s still high, but it’s nowhere near what it was back then. In a nutshell, we have better, more seasoned companies. The environment is more hospitable from an interest rate environment. If we’re focused on the bigger names and the benchmarks, the overvaluation is not as extreme as when you start looking at things like Fastly and Okta and things like that. And we do have some megatrends that are actually supportive of the sector, whether it be the cloud transition or digital transformation, 5G, etc. Those are big trends and they’re certainly there.

Well, Marcello, why don’t we stop there for today because we want to get you back. That was just a fascinating overview of what was then versus what is now, and the reasons to think about this differently. But another big thing are these megatrends. So why don’t we get you back over the next couple of weeks and we’ll delve into some of those trends that are having such a big impact, not just on technology stocks, but on the world as a whole, because I think that would be a fantastic discussion.

Sure. Sounds great.

Great, Marcello. Thank you very much for your time today. And I know everyone’s looking forward to having you back. And we’ll see you back with the download over the next few days. Thank you very much.

Thank you, ciao.


Recorded: December 8, 2020

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