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Tall tree in the spring
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Are tech stocks in a bubble?
It’s a question that markets observers pose frequently, in part because the good times just keep rolling on for stocks like Amazon.com Inc. AMZN, +1.04%, Apple Inc., AAPL, +2.15% Facebook FB, +1.36%, and Netflix NFLX, -0.85%, and perhaps in part because overvalued tech stocks bursting in spectacular fashion is a script we’ve seen in not-too-distant memory.
BCA Research tackled that question several times over the summer.
“We believe that tech stocks are in a bubble,” wrote Mathieu Savary, in its signature piece known as the Bank Credit Analyst, “and the mania will expand further as long as inflation remains low and monetary conditions stay accommodative, despite occasional pullbacks. Moreover, the broad market will suffer when the bubble eventually bursts.”
In a more focused note out August 21, BCA Chief Global Strategist Peter Berezin lays out several reasons why he thinks tech’s outperformance can’t last.
Among them are some technical factors. For example, value, not growth, stocks generally do better when the U.S. dollar is weakening, as it is likely to continue to do for some time. In contrast, tech stocks tend to outperform when inflation and interest rates are falling, a condition Berezin argues isn’t likely to continue.
But mostly, Berezin points out that in markets, everything eventually reverts to the mean. The tech sector has benefited from bricks-and-mortar stores being closed down during the coronavirus pandemic – and people reluctant to visit them, once reopened. Berezin cites an estimate from Bank of America that suggests the US e-commerce penetration rate more than doubled over the past year, from 16% to 33%, “representing more than ten years of growth in only a few months.”
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E-commerce will grab even more market share from here, he writes. But as lockdown measures ease, there will be a bounceback for in-person shopping. “This could produce a temporary air pocket in sales for online sellers, a risk that does not seem to be fully discounted.”
What’s more, as the old saying goes, trees don’t grow to the sky. Put another way, as Berezin does, “many marquee tech companies have become so big that further gains in market share may be difficult to achieve.”
Nearly three-quarters of American households have an Amazon Prime account, he says, and slightly over half have a Netflix account. Globally, Netflix subscriptions jumped 27% year over year in the second quarter as people stayed home. That juiced second-quarter results, but, as Berezin puts it, “If someone did not bother to purchase a Netflix subscription in March or April, how likely is it that they will subscribe for the first time in September?”
Stocks in the Nasdaq-100 have had annualized earnings per share growth of 16% since 2010, 2.5 times the pace of the S&P 500 index and 3.2 times faster than the non-IT stocks of the S&P 500, Berezin writes. Looking ahead, analysts project earnings growth of 27% for the S&P 500 in 2021, verus 20% for the Nasdaq.
But that also would reflect the “collapse” in most non-tech stocks during the pandemic, Berezin admits. Is a 27% gain from a low base really that much better than a 20% gain in a tried-and-true growth stock?
Time will tell. Berezin ends his analysis by noting that “history is littered with tech companies that failed to keep up with a changing world: RCA, Kodak, Polaroid, Atari,” and many more. But it’s worth noting that many of the current crop of tech giants have adapted, and dominated, through multiple market and technological cycles.
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