What was the Dotcom bubble?
The Internet bubble, also known as the Internet bubble, was a rapid rise in valuations of US technology stocks, fueled by investments in Internet-based companies during the bull market in the late 1990s. During the Internet bubble, the value of the stock markets increased exponentially, the Nasdaq index dominated by technology going from less than 1,000 to more than 5,000 between 1995 and 2000. In 2001 and until 2002, the bubble burst, equities entering a bear market.
The crash that followed saw the Nasdaq index, which had quintupled between 1995 and 2000, fall from a peak of 5,048.62 on March 10, 2000 to 1,139.90 on October 4, 2002, a drop of 76, 81%. By the end of 2001, most dotcom shares had gone bankrupt. Even the share prices of leading technology stocks like Cisco, Intel and Oracle have lost more than 80% of their value. It would take 15 years for Nasdaq to regain its dotcom peak, which it did on April 23, 2020.
The Internet bubble is just one of the many asset bubbles that have appeared in recent centuries.
Explain the Dotcom bubble
The dotcom bubble was born from a combination of the presence of speculative or fashionable investments, the abundance of venture capital funds for startups and the inability of dotcoms to generate profits. Investors invested money in Internet startups during the 1990s in the hope that these companies would one day become profitable, and many investors and venture capitalists abandoned a cautious approach for fear of not being able to take advantage of the growing use of the Internet.
With capital markets injecting money into the sector, start-ups were racing to quickly grow large. Companies without proprietary technology have abandoned tax liability and spent a fortune on marketing to create brands that stand out from the competition. Some start-ups have spent up to 90% of their budget on advertising.
Speculative bubbles are notoriously difficult to recognize when they appear, but seem obvious after they burst.
Record amounts of capital began flowing into the Nasdaq in 1997. In 1999, 39% of all venture capital investment went to Internet companies. That year, 295 of the 457 IPOs were linked to Internet companies, followed by 91 in the first quarter of 2000 alone. The highlight was the AOL Time Warner megamerger in January 2000, which would become the biggest merger failure in history.
Fed Chairman Alan Greenspan warned the markets of their irrational exuberance on December 5, 1996. But he only tightened monetary policy in the spring of 2000, after banks and brokerages used the excess liquidity created by the Fed before the Y2K bug, to finance Internet stocks. After pouring gasoline on the fire, Greenspan had no choice but to burst the bubble.
The bubble finally burst dramatically, leaving many investors facing significant losses and several Internet companies going bankrupt. The companies that survived the bubble are Amazon, eBay and Priceline.
Key points to remember
- The value of stock markets increased exponentially during the internet bubble, with the Nasdaq rising from less than 1,000 to more than 5,000 between 1995 and 2000.
- Stocks entered a bear market after the bubble burst in 2001.
- The Nasdaq, which quintupled between 1995 and 2000, fell by almost 77%, resulting in a loss of billions of dollars.
- The bubble also caused the bankruptcy of several Internet companies.
How the Dotcom bubble bursts
The 1990s were a period of rapid technological progress in many areas, but it was the commercialization of the Internet that led to the greatest expansion of capital growth the country has ever known. Although holders of high-tech standards, such as Intel, Cisco and Oracle, spurred organic growth in the technology sector, it was the point-upstar companies that fueled the market boom that began in 1995.
The bubble that has formed over the next five years has been fueled by cheap money, easy capital, excessive market confidence and pure speculation. Venture capitalists eager to find the next big score freely invested in any business with a “.com” after its name. The valuations were based on profits and profits that would not occur for several years if the business model really worked, and investors were too willing to ignore traditional fundamentals. Companies that had not yet generated revenue, profits and, in some cases, a finished product, went to the market with initial public offerings that saw their share prices triple and quadruple in one day, creating a food frenzy for investors.
The Nasdaq index peaked on March 10, 2000, at 5048, almost double compared to the previous year. At the height of the market, several of the major tech companies, such as Dell and Cisco, placed huge sell orders on their stocks, causing investors to panic. In a few weeks, the stock market lost 10% of its value. As private equity began to dry up, so did the cash-strapped dotcom companies. The dotcom companies that had reached a market capitalization of several hundred million dollars became worthless in a few months. By the end of 2001, the majority of publicly-traded endowment companies retreated and billions of dollars of investment capital evaporated.