It was late 1999, and I was questioning my entire investing career.
My wife had just told me about a conversation she had while baking Christmas cookies at our home with two friends. One of the young women remarked that she and her husband were planning to quit their jobs at a non-profit. Her husband was making so much money “day-trading” stocks with their savings that he wanted to do it full-time. The other friend turned to my wife and murmured, “Your husband isn’t doing that for us.”
Over the previous 15 years, I had learned to buy stocks as ownership pieces of real businesses. I diligently studied company financial statements, industry reports and trade magazines to determine which (if any) I would feel comfortable buying for our clients. But by late 1999, this disciplined approach felt obsolete—and it seemed to hamper our portfolio returns.
A Bold New Era
By the end of that year, speculative stocks completely lapped pedestrian, “old economy” companies. The Nasdaq Composite Index (which counted a number of tech, bio-tech and communications stocks in its membership) delivered a jaw-dropping total return of 86%—which remains the greatest single-year gain for any major stock index in U.S. history. The S&P 500, buoyed by a few tech giants, achieved a wonderful 20% return. Meanwhile, the Russell 2000 Value Index declined nearly 4%. It wasn’t a disaster, but it looked like a failure by comparison.
Market pundits claimed we had entered a “New Era.” They argued that the traditional rules of economics, valuation, and business cycles were permanently suspended. The internet would create a frictionless world of growth, while central banks would engineer low interest rates and low inflation. The consensus was summarized in four provocative words: “This time it’s different.” Old codgers warned that this exact mentality had destroyed massive amounts of wealth, but their voices were drowned out by the roar of the new economy.
That same December, my boss sent me a note that challenged Warren Buffett’s investing prowess. In this piece, the author pointed out that his elderly mother was vastly outperforming the noted investor simply by buying trendy momentum stocks. My boss circled the headline, wrote a bold “FYI,” added his initials, and routed it to my desk. Similar scathing critiques of Buffett were printed in Barron’s and Forbes—two former ultimate bastions of old-school investing.
It was a tough time to be an investor. Several managers I respected chose to retire—or had the choice made for them because of fleeing clients. Julian Robertson summed up the situation perfectly when he closed his legendary Tiger Fund in March 2000, stating:
“The current technology, Internet and telecom craze…is unwittingly creating a Ponzi pyramid destined for collapse. The tragedy is, however, that the only way to generate short-term performance in the current environment is to buy these stocks. That makes the process self-perpetuating until the pyramid eventually collapses under its own excess.”
I have to admit, walking away from investing certainly seemed tempting. But leaving wouldn’t be running away to join the circus—it would be fleeing the Big Top right before the main tent collapsed. I was exhausted by the barrage of questions about why our portfolios weren’t keeping up with the New Age. However, two things kept me anchored. First, I was 39 with a young family to support. More importantly, I couldn’t shake the nagging dread of what would happen to our clients if they transitioned to a manager steeped in “New Era” thinking. We had a duty to protect them. But, we’d need to stick to our investment principles, and we had no idea how long we (and our clients) would need to lean against the wind.
It probably would help for me to explain why investors like us thought that the “New Era” model was so dangerous. It had created a powerful narrative to explain how the stock market would work going forward—one where people no longer paid attention to mundane things like earnings, price, valuations, costs, or even revenues. Instead, key metrics were ‘eyeballs’ ‘clickthrough rates’ ‘route miles’ of fiber cable, ‘homes passed’ and the like. In order to score these metrics, emphasis was placed on “first-mover advantage” and “getting big fast.” Only those companies would win, and they would win big.
By February 2000, the index clearly reflected the “New Era” narrative. Information technology companies accounted for over 33% of the index—including giants like Cisco Systems, Microsoft, Intel, Oracle, IBM, and Lucent—while telecommunication services (such as AT&T, WorldCom, SBC Communications, and BellSouth) added another 7.5%. Combined, roughly 40% of the S&P 500 was riding on the idea that building out internet hardware and infrastructure would be a highly lucrative investment.
A Look Under the Hood of the S&P 500
A quick note on how the S&P 500 actually works is probably in order. It isn’t just a list of the 500 largest US companies—as S&P itself puts it, the index features “500 leading companies” that represent about 80% of total US stock market value, with a selection committee deciding when to swap companies in or out.
More importantly, it is market value weighted. Rather than every company holding an equal 1/500 (0.2%) weight, larger companies command a far greater share. When a few massive companies rise or fall, they heavily impact the entire index, while smaller members barely move the needle at all.
The point is: the S&P 500 doesn’t show you what the average stock price is doing; it shows you how the market’s total capital value is shifting.
The Cookie Crumbles
Starting in March 2000, however, the New Era received a devastating comeuppance.
Over the next three years from peak to trough, the Nasdaq collapsed by 77%. The S&P 500 was cut in half. Trillions of dollars of wealth evaporated. Meanwhile, that pedestrian Russell 2000 Value Index managed to gain 11% over the period. It turned out that leaning against the wind wasn’t crazy; it could be helpful.
And it’s not as if the internet turned out to be a fizzle. The internet really did change how business gets done. But it wasn’t the case that the stocks of these companies represented once in a lifetime opportunities to create wealth.
To today’s reader, this all sounds like ancient history. You almost would need to be a trivia buff to know very much about it. Many of you didn’t experience the dot-com crash firsthand as an investor. Hearing about it is like reading about a massive earthquake in another country—it sounds terrible, but it didn’t shake your floor.
Here’s the thing: you don’t have to feel the ground shake to build an earthquake-protected house. It is always better to learn from history than to pitch your tent directly on a fault line.
Can History Rhyme?
Today, the rhetoric sounds remarkably similar. We are told that traditional valuations, earnings, and free cash flow take a back seat to new metrics: ‘compute utilization,’ ‘time-to-million users’ and ‘algorithmic scaling.’ Once again, the goal is to ‘get big fast,’ operating under the assumption that the first mover will capture an unsurpassable advantage.
The mantra of “this time it’s different” has reappeared. Now we are told that we have entered the “Intelligence Age,” an era where marginal costs drop to near zero, the need for labor declines, and society must rewrite the rules of economics because human work is becoming obsolete.
The S&P 500 reflects this. As of June 30th, Information technology companies (which include NVIDIA, Apple, Microsoft, Broadcom, and Micron) compose almost 38% of the index with communications services (companies like Alphabet “Google”, Meta Platforms, and Netflix) approaching 10%.
To me, this script is nearly identical to the one written 25 years ago. Except that today, nearly half of the S&P’s capitalization is composed of New Era companies.
Where We Stand
I’m not predicting artificial intelligence will be a bust—just as the internet wasn’t a bust. However, I don’t believe that the stocks of many of these companies represent once in a lifetime opportunities to create wealth at current prices.
Like the internet, it could be the case that AI will change how business gets done. It may make some firms more profitable as they become enabled to reduce costs and focus on revenue-producing opportunities. But it also may be the case that excess rewards may accrue more to these companies than they will to those who simply create the AI “machinery.”
So if the stocks I own “zig” while others “zag,” I don’t panic. I recognize that technology changes, but human psychology and structural economics do not.
Could this time truly be different? Perhaps AI will seamlessly enrich every human on earth and erase the business cycle forever. But until that happens, the pressure on you to “get with the new economy” will remain intense. We urge you to remember that prudence is never outdated. In fact, current market valuations require far more prudence than usual.
We know firsthand that watching exciting sectors of the market sprint ahead without you can be emotionally exhausting—I still remember the sting of the Christmas cookie comment over 25 years later. We believe your patience and partnership will allow us to focus on protecting and growing your wealth over the long haul.
Please call us at (402) 991-3388 with your questions, concerns, or thoughts. We are here to navigate these eras with you.
Eric Ball, CFA
Managing Director & Chief Investment Officer
America First Investment Advisors, LLC
Omaha, Nebraska
Disclaimer: Please remember that investment advice and financial strategies involve risk, and there is no guarantee that your financial goals will be achieved. Indices are unmanaged and cannot be invested in directly. Index returns don’t reflect fees, expenses, or transaction costs that a client’s account would incur. Past performance (of an index or otherwise) is not indicative of future results. The information provided in this article is for general guidance only and does not constitute personalized financial advice. It is essential to consult with your financial advisor, a tax consultant, and an estate attorney to discuss your specific circumstances.