There are some unnerving parallels between today’s market environment and the dot-com bubble in 2000, and that has many investors on edge. But there’s something important that you may not remember from the dot-com bust, and this missing piece could help you navigate changing markets in 2021.
If you were invested when the dot-com bubble burst, it can feel alarming to see some of the similarities between what’s happening in the market today. Once again, some stocks are richly valued. “By a variety of measures, including price to expected earnings and price to the past decade’s inflation-adjusted earnings, equities have never been so expensive outside of the dot-com bubble years,” the Wall Street Journal explained.
There’s been another spike in IPOs: “Initial public offerings, when companies issue new shares to the public, are having their busiest year in two decades — even if many of the new companies are unprofitable,” the New York Times NYT wrote at the end of 2020.
And the recent GameStop GME rally was a sign that we may be in another market environment where individual investor money flows trump fundamentals.
Of course, it’s also worth noting that the current market could simply be a result of low interest rates. It’s logical to see higher demand for stocks when bond yields are so low.
With so much media attention on a potential stock market bubble, many investors are wondering what they should do now, and the 2000 tech bust could provide an important lesson.
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What you may not remember about the dot-com bubble in 2000
When the internet bubble burst in 2000, it triggered a massive stock market decline. Many investors saw their wealth cut in half (or worse) and the losses had a lasting effect on investors, some of whom swore off stocks and missed out on one of the longest bull markets in history.
But there’s another important detail about the dot-come bust that often gets overlooked: when the tech bubble burst in 2000, it didn’t affect every area of the market in the same way. Large-cap growth and technology stocks plunged, while value stocks had gains. The tech-focused Nasdaq Composite Index fell -39.0% in 2000 while the Wilshire 5000 Large Cap Value Index gained 17.0%.
This divergence gave active investors a way to take shelter in the storm. Investors who shifted their portfolios from large-cap growth to value funds, as my firm did, were able to avoid the worst of the losses and end the year with gains.
In challenging markets, some areas typically hold up better than others, and that may prove to be an important investment opportunity in 2021 as it was in 2000.
2021 brings new investment opportunities
Markets have been changing in recent months. As the trend moves away from large-cap growth stocks and tech companies, new opportunities have emerged in small-caps, value, and foreign stocks.
The small-cap Russell 2000 Index gained in January, while large-cap indexes like the S&P 500 and the Dow fell. Over the last three and six months, value stocks have outpaced growth stocks, and foreign stocks have also done well.
My firm specializes in navigating changing markets, and we’ve already made some initial changes to our mutual fund and ETF portfolios to add exposure to these new leading areas. We’ve trimmed our tech and large-cap growth exposure in favor of smaller-cap and foreign funds, including iShares Russell 2000 IWM , Vanguard International Growth (VWIGX), and Matthews Asia Growth (MPACX).
We’ve also diversified our large-cap growth exposure with a position in SPDR Barclays Convertible Securities ETF (CWB). Convertible securities are typically lower-quality debt securities that can be converted into shares of common stock. Convertibles are highly correlated to equities and often perform more like stocks than bonds. (Disclosure: I own most of these funds and ETFs personally through my investments in the funds of funds that FundX manages.)
If we end up seeing a bubble in large-cap or tech stocks this year, smaller-cap, value, and foreign stocks could give active investors somewhere to turn, so pay attention to changing market trends and make sure you have a strategy that can help you respond to these changes.
Janet Brown is editor of NoLoad FundX and president and CEO of FundX.