Call It a Bubble, Call It Excess. Here's What to Watch If Tech Goes Pop

By James Mackintosh

In just seven days, $1 trillion vanished from the value of seven of the big U.S. growth stocks. One trillion dollars. Investors unexpectedly getting a lot poorer has had nasty repercussions in the past. What can we expect if this year's wild excess around disruptive technology stocks continues to deflate?

In extreme cases, bursting bubbles sometimes trash the entire economy, as with Britain's 1846 Railway Mania, Japan's 1989 property-and-equity bubble or the pre-2007 housing-and-structured-debt bubble.

The good news is that the tech excess -- I hesitate to call it a bubble -- hasn't been accompanied by an investment boom financed by new stock or debt. There are exceptions, such as Tesla, which need regular injections of new cash and would have to slow their expansion if markets turned against them. But there's no reason why Apple, Amazon or most of the rest of Big Tech would have to cancel projects even if their stock prices halved.

The bad news is that there are plenty of other ways that falling stock prices can hit both the economy and the rest of the market.

Past bubbles have been followed by a mix of financial disruption, higher household savings and sudden changes to corporate behavior as the stock market shifts its incentives. A continued fall in tech stocks carries some of these risks.

If investors have borrowed heavily to buy an asset and it falls fast, they become forced sellers, accelerating its decline. If they lose enough, or they have other borrowing, they may sell other holdings, leading to falls elsewhere in the market. There's little sign of this so far; while growth stocks have plunged almost 9.6% from this month's high, according to Russell 1000 indexes, disregarded value stocks are down less than 4%.

Still, margin lending is high -- it's been higher only from late 2017 through to the recession panic of late 2018, according to figures from the Financial Industry Regulatory Authority. So this remains a risk if tech carries on down.

While Apple, Amazon and the like won't need to slash spending even if their shares crash, worthless employee stock options would make them less attractive to work for. Equally, the venture-capital-backed ecosystem of the West Coast will become less appealing if tech startups don't have the exit route of an overvalued IPO. Knock-on effects of a crash on wildly overpriced San Francisco property could hurt the local economy.

Yet, the broader economy is at much less risk today than at the time of past bubbles. Companies that couldn't issue new stock after the dot-com bust went to the wall. Big telecoms businesses that had borrowed far too much to build global fiber and mobile networks failed or slashed investment when they couldn't refinance and demand turned out to be much lower than expected -- just as with the railways in 19th-century Britain. Amazon, Alphabet and Apple have been financing their expansions internally, so have no need to scale back as their stock falls.

And falling stock prices have a much smaller impact on consumer spending than housing slumps. The wealth effect -- consumers who feel richer spend more -- was obvious in the years leading up to the 2007-08 financial crisis as borrowers remortgaged to spend, backed by higher house prices. But stock prices don't have that same effect, partly because we're used to them going up and down, but mainly because so few people now own stock directly.

It's true that since the financial crisis far more people have been punting on share prices thanks to free trading at Robinhood and the lack of sports to bet on. But it's hard to believe that enough people became so much better off -- and now worse-off -- that they will make economically significant cuts to spending in order to save.

One final risk that I didn't mention, because I don't know how to assess it, is psychology. When the market leaders fall, traders and investors (and the momentum-driven market bots) might just become more cautious, hurting everything. So far this hasn't happened, with many of the lockdown losers rising strongly this month even as the year's big winners went into reverse. At one extreme, all 22 of the S&P 500 stocks up more than 50% by the end of August fell this month. At the other, all five S&P stocks up more than 10% this month had fallen by more than a third in the year to August.

All of the above assumes that the tech rout gets worse, which is far from a given. Blow off the froth of the late-summer excess and the big growth stocks are still expensive compared to history. But consider the superlow yields on Treasurys and the ability of many of them to ride out a weak economy and they are much more justifiable -- at least so long as yields stay low and the economy weak.

Write to James Mackintosh at [e-mail]