Tag: Pessimism

29
Sep
2020
Posted in technology

The Current Tech Stock “Bubble” Reflects Pessimism, Not Optimism

Since the U.S. stock market started its rebound in early April of this year, technology has been the leading sector. Driven initially by mega-cap tech behemoths Amazon
AMZN
, Apple
AAPL
, Facebook, Google
GOOGL
, and Microsoft
MSFT
, the tech rally has spread into some fast growing mid- and small-cap stocks as well as high-profile IPOs like Snowflake. 

Many investors and pundits are concerned that tech stocks are experiencing a bubble, as in 1999‒2000. However, instead of excessive optimism about the future, rising tech valuations may reflect pessimism about future economic growth and profit weakness in other sectors. Given the current high unemployment rate of 8.4% and the large number of small business closures, Consumer Cyclical, Basic Material, and Energy stocks could have muted profits for an extended period. Technology’s secular growth, fueled by the Internet, cloud computing, ecommerce, and the ongoing digital transformation of business, is simply more attractive to investors than most other parts of the market.

S&P 500 overall earnings are expected to decline 3% in 2020 when companies with losses are excluded (see table above). However, Wall Street is optimistic for 2021, expecting a 13% bounce in profits. Many of 2020’s worst sectors are expected to have the highest earnings growth next year. Cyclical groups are expected to have the fastest profit growth, led by Energy (+20%), Transportation (+19%), Consumer Cyclical (+19%), and Basic Material (+18%). In contrast, Technology is only expected to grow roughly in line with the overall market at +14%. Given Technology earnings’ modest expectations and comparatively secular nature, the sector is more likely to meet earnings expectations than cyclical sectors with higher expectations. 

I believe investors are still cautious or negative on the U.S. economy, so they will pay a premium for Technology stocks