Productivity After the Dot-com Bust
Forget about equations and forecasts. Powerful economic concepts have given rise to companies and transformed industries. Ignore economists at your peril.
October 2014 | by John Olivier, Chief Investment Officer
During the dot-com bubble, managers and investors lost sight of what drove return on invested capital; indeed, many forgot the importance of this ratio entirely. When Netscape Communications went public in 1995, the company saw its market capitalization soar to six billion on an annual revenue base of just eighty-five million, an astonishing valuation. This phenomenon convinced the financial world that the Internet could change the way business was done and how value was created in every sector, setting off a race to create Internet-related companies and take them public. Between 1995 and 2000, more than 4,700 companies went public in the United States and Europe, many with billion-dollar-plus market capitalizations.
This growth reflected numerous interrelated trends, including advances in information and communications technology, financial market liberalization, and innovations in financial products and services. We witnessed the takeoff of financial globalization. Meanwhile, cross-border capital flows—such as foreign direct investment, purchases and sales of foreign equities and debt securities, and lending and deposits—plummeted eighty-percent, to just two-trillion at the end of 2008. Financial globalization has stalled and in some cases even reversed as investors, companies, and banks sold foreign assets and brought their money back to their home countries.
Going forward, we expect that global capital markets will expand again once the crisis has passed. But mature market financial assets are likely to grow more slowly than before, more in line with GDP, for several reasons. Many analysts forecast GDP growth in developed economies to be more modest in coming decades than in recent years due to aging populations and mounting government debt. These economic projections give little reason to hope that earnings and valuations will rise again to significantly and sustainably higher levels in mature markets.
More specifically, we see potential for growth by looking at individual asset classes. Equities, for example, are the second-largest asset class after bank deposits in virtually all emerging markets. Yet they can grow more as state-owned enterprises are privatized and as existing companies expand. For instance, we estimate that just a quarter of the value of Chinese corporations is listed on public equity markets, compared with more than seventy percent of US corporations. Likewise, nascent markets for corporate bonds and other private debt securities in developing economies could flourish with significant legal and financial reforms.
The full ramifications of the crisis will take years to play out. It remains unclear at this time, for instance, whether we will see financial globalization resume at the same pace as before. But it is already clear that the financial landscape has shifted in several ways. Mature markets will grow again, but probably not at the heady pace of recent years. Meanwhile, for investors and financial intermediaries alike, emerging markets will become more important as their share of the global capital markets continues to expand.