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How Not to Diversify and Other Lessons of the Tech Bubble

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Thinking back on all the mistakes his clients made as the dot-com bubble inflated two decades ago, Dan Morgan remembered some funny ideas about diversification.

“They’d say ‘I own Microsoft, Dell and Intel,’” said the 52-year-old fund manager at Synovus Securities Inc., recounting a strategy that proved ruinous as those stocks plunged an average of 72 percent starting in March 2000. The Nasdaq Composite Index has only now recovered from the carnage, closing at a record high for the first time in 15 years.

Computer and software stocks were a religion in the 1990s, more so than now, and nobody wanted anything else, Morgan said. One guy sold his employment agency in Ohio before the bubble burst and plowed several million dollars into 60 companies.

“At least 45 of them were in technology,” said Morgan, who worked at Noble Capital Management in Boca Raton, Florida, during the dot-com craze. “He just wouldn’t budge. He was adamant he was correct and he probably got obliterated.”

Today is different, going by returns. While the Nasdaq Composite has jumped more than 290 percent in the bull market that began in March 2009, technology stocks are only the fourth-best performers in the Standard & Poor’s 500 Index. In the 1990s, they rose almost four times as fast as anything else.

Buying, Selling

Robert Pavlik could never put down the phone in 1999, taking orders at Matrix Capital Group and buying and selling stocks like America Online Inc. four or five times a day. The Nasdaq rose 1,150 percent from trough to peak in the 1990s, then gave almost 80 percent of the gains back in 30 months.

“If you explained to a client then that you weren’t investing in AOL or some of those other companies because you saw them as mania or a fad, people would look at you as if you were completely lost,” said Pavlik, now chief investment strategist for Boston Private Wealth.

The Nasdaq Composite climbed 0.6 percent to 5,088.53 at 9:56 a.m. in New York, extending its rally as Amazon.com Inc. soared 14 percent and Microsoft Corp. jumped 6.1 percent.

While prices today mirror those of 15 years ago, that’s where most of the resemblance stops, money managers said. Consider that the Nasdaq Composite swung an average 7.8 percent each month in 1999 to surge almost 86 percent for the year. In 2014, monthly fluctuations averaged 2.8 percent, en route to a 13 percent gain.

Fifteen years ago, the 10 top performers in the Nasdaq 100 Index posted annual gains of 722 percent, compared with 75 percent last year. Cisco Systems Inc.’s return from 1991 through 1999 comes out to 100 percent per calendar year.

“I thought I’d seen everything, and I clearly hadn’t,” said John Manley, chief equity strategist for Wells Fargo Funds Management in New York. “I don’t think I’ve ever encountered a force of nature like that. The sheer pressure to believe in it was overwhelming.”

Baseball Stadiums

Fortunes were made and lost, month to month. Between mid-December 1998 and early April 1999, America Online jumped from $50 to $165 -- and then it went from $82 to $186 from September 1999 to December 1999. Yahoo! Inc. traded at $44.50 on Nov. 2, 1999, and was above $100 by Christmas of that year.

To Jim Paulsen, who was the chief investment strategist at Wells Capital Management 15 years ago, froth was everywhere.

“I could remember going to San Francisco Giants ballgames when they just opened up the stadium, and the only advertisements that were up were dot-com companies,” Paulsen, who holds the same role at Wells Capital in Minneapolis, said by phone. “There was this feeling, ‘This is nothing like ever before and it’s changed all the rules.’”

While the Nasdaq 100 trades for about 23.5 times full-year earnings today, too few of its companies were posting profits even to calculate a ratio in 2000. Then, Cisco rose as high as 230 times earnings, while EMC Corp.’s valuation rose to more than 200 times profit.

Euphoric Clients

George Young, a partner at St. Denis J Villere & Co. in New Orleans, avoided technology stocks, convinced companies needed to make money to stay in business. Clients came to the office and yelled at him, but in the end were spared the bust.

“I was friends with a professor nearby at Tulane University,” Young said. “Their undergrad business professors had given their students an assignment to look at P/E ratios, and the students would come back saying ‘I found the P, but couldn’t find the E.’ There were no earnings.”

Marshall Front, the Chicago-based chief investment officer at Front Barnett Associates LLC during the tech bubble, was rebuked by a client after he sold Cisco on two occasions: once when the stock climbed to $70, next when it hit $80.

“It was as if it was his company, that he built up and put in the portfolio, and he was pissed that it was leaving by my hand,” Front, who has the same role at the firm, said by phone. “At $80, I sold more of it and as soon as he got wind of it he berated me. I can’t recall how many times this happened.”

After the bust came, everyone said they got out at the top, but nobody really did, according to Jeff Sica, president of Circle Squared Alternative Investments in Morristown, New Jersey. Sica was at A.G. Edwards Inc. in the 1990s.

‘They Weren’t’

“I wish I could say I was too smart to participate,” Sica said. “The pressure was relentless back then because the fear of missing out exceeds the fear of losing,” he said. “There were a bunch of people who had stepped out and were really big bulls at the top, then came out later saying they were warning people. No, they weren’t.”

More than 880 companies went public on the Nasdaq Composite in 1999 and 2000, compared with 315 over the last two years, data from Nasdaq OMX Group Inc. show. The dot-com bubble was marked by unprofitable Internet companies selling shares for the first time, such as Pets.com Inc. and online grocer Webvan Group Inc.

“We haven’t had the IPO boom that has produced a large crop of new names,” John Carey, a Boston-based fund manager at Pioneer Investment Management, said by phone. He has been in the same role for almost 36 years. “I was getting two or three IPO prospectuses a day. It was a very frothy time when a lot of new names rose to ridiculous prices very quickly.”

Few Survive

Only a handful of Internet startups from the class of 1999 survive today with their identities intact. Gone are the likes of Webvan, eToys Inc. and Lycos Inc. The biggest weighting in the Dow Jones Internet Index in March 2000, America Online, survives as AOL Inc., with a market capitalization of $3.2 billion -- about 1.9 percent of its level in 2000.

Today, investors view technology stocks in a more measured and skeptical manner, instead of irrationally buying like they did 15 years ago, said Jim Russell, who was a Cincinnati-based vice president and director of equity research at Fifth Third Bank back then.

“The valuations on those companies simply got too high,” Russell, a portfolio manager at Bahl & Gaynor Inc. in Cincinnati, said by phone. “We think the stocks now are being valued on a much more rational basis relative to the days of speculative, Internet-driven stocks.”

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