Quiz!
How long did it take the Nasdaq to reach a new peak after the 3/10/2000 peak?
- It kept on going up – the Nasdaq doesn’t decline given the solid technologies produced by the companies in it
- 3 years
- 6 years
- 10 years
- 14 years
- It is unknown yet – it is still recovering.
How Do Tech Bubbles Pop?
On 1/27/2025, Nvidia and Broadcom stocks declined 17%. Why would the stocks of two of the leading AI companies in the world get hit so hard? This was in response to Chinese DeepSeek’s AI competing with ChatGPT, while its API access (access for programmers) is offered at less than 1/50th (2%) of the price of the ChatGPT API.
This is a common step in tech bubbles, going at least as far as the Roaring 1920’s (commercialization of the radio, TV and more) that were followed by the Great Depression. Here are typical phases of tech bubbles, from formation to popping:
- A new technology is introduced offering great value.
- As the technology gets demonstrated and improved, adoption increases, providing great profits to the companies offering it.
- The stock prices of companies offering the technology increase given their profitability.
- At some point, many investors buy the stocks given past returns and the future promise, while ignoring valuations, such as Price relative to Earnings and Book Value (P/E and P/B). That is when the gains form a bubble and can be seen with a spike in valuations.
- In the meantime, two effects happen:
- Economies of scale lower the cost to produce products with the technology.
- Competition, with a focus on efficiencies, offers the technology at much lower costs.
- As competition increases and costs go down, the entire industry lowers the prices. This includes the original companies offering the technology.
- With much lower prices, profitability of the producers of the new technology goes down, and the prior valuations become disconnected from reality, leading them to decline.
- That leads to a crash in those technology stocks, all while offering a very valuable service.
- While there is a logical progression, the timing isn’t easy to identify in advance.
Was 1/27/2025 the peak of the current tech bubble? It is tough to say, before reaching the depths of the decline. In 2022, we got a false peak with the tech-heavy Nasdaq declining a mere 33% (vs. the 78% decline in the dot-com crash that started in 2000). After 1 year, it bottomed and reached new highs less than 2 years later.
Once the real decline starts, how long can it take to recover? As typical, there are no guarantees in investing. Having said that, there has been a correlation between the excess valuations (relative to the typical) and the length of the decline.
- In the 2000’s the S&P 500 took over 10 years to recover, with a 30% decline a decade after its peak.
- In 1989 Japan reached significantly higher valuations that led to a decline to recovery of over 30 years, given much higher peak valuations.
- Fast-forward to 2025: The P/B (or Price/Book) of the S&P 500 on 1/27/2025 was slightly higher than the highest point in 2000, so another “lost decade” shouldn’t surprise us.
Quiz Answer:
How long did it take the Nasdaq to reach a new peak after the 3/10/2000 peak?
- It kept on going up – the Nasdaq doesn’t decline given the solid technologies made by the companies in it
- 3 years
- 6 years
- 10 years
- 14 years [The Correct Answer]
- It is unknown yet – it is still recovering.
Explanation: The Nasdaq declined by 78% over a span of 2 years and 7 months, followed by a long road to recovery, with a total of 14 years peak-to-peak.
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