3 reasons why this isn't a tech bubble

With the exceptionally strong performance of tech stocks over the past year-plus, some investors have been wondering whether tech could be in a bubble—similar to the dot-com bubble of the late 1990s, which then burst and led to a deep bear market over 2000 to 2002.

My research focuses on using historical market data to uncover patterns and probabilities that can help inform the current outlook, and that can help challenge some of the subjective views and biases that we all sometimes bring to the table as investors.

Currently, I'm seeing at least 3 reasons why tech's latest rise does not look like a bubble, and instead looks sustainable. At the same time, I'm also seeing at least 2 reasons why tech shouldn't be the only thing you own, and why investors should still have exposure to other sectors.

Read on for 5 key observations that can help put tech's latest rise into perspective.

1. Tech valuations are not at extremes

A bubble is a disconnect between how stocks are valued (i.e., the prices they trade for), and their fundamentals (i.e., their earnings, cash flow, book value, or other financial metrics). Looking at long-term valuations for the sector, I don't see that kind of a disconnect today.

As the chart below shows, at the peak of the tech bubble the sector traded at a forward price-earnings (PE) ratio of almost 60. But recently the sector's PE ratio has been at only about half that level.

If you compare the sector's valuation to that of the broader market then the picture looks even less worrying. Yes, tech stocks have gotten more expensive recently—but so has the entire market, on average.

2. Earnings are coming through—supported by margins

Tech has been delivering the goods when it comes to earnings. This has been primarily driven by margin expansion (meaning, for every dollar of sales, how much money does a company end up keeping in the form of operating profits). As the chart below shows, operating margins aren't far from all-time highs, and they've been generally improving.

This improvement is thanks to more than just the so-called Magnificent 7 (the 7 mega-cap tech companies that have dominated market gains in the last year). The data above is based on an equal weighting of S&P 500 tech companies, so those largest companies have a comparatively modest impact on the figures. Rather, the sector has been seeing margins expand across the board.

3. Earnings momentum is giving a bullish signal

Another metric I've been following has been earnings momentum. The chart below shows this by comparing the forward earnings estimates, for tech at a given point in time, to forward earnings estimates from a year prior.

If you look at the most recent upturn, it looks a bit like a hockey stick—showing strong positive momentum. Usually, we only see that kind of a "hockey stick" formation on the way out of a recession, and the 2 most recent other times we've seen it have been coming out of the pandemic and coming out of the 2007 to 2009 bear market. What it has historically signaled is that this kind of an earnings recovery is durable—meaning, we've then seen higher odds of continued earnings growth in the second or even third year after that inflection point.

Furthermore, historically, the greater the momentum, the more likely it is that the stocks advance and that they outperform the market. In this case, we've seen top-quartile momentum (measured by the steepness of the hockey stick's rise).

In other words, it's not just that tech doesn't look like a bubble—it could still have more room to run.

4. That said, tech's relative performance has indeed been extreme

Looking ahead, investors need to balance this strong case for tech against some subtle caveats.

One reason why investors have felt that tech might be in a bubble is because it has performed so disproportionately, relative to other sectors. I've been studying this by looking at tech's performance relative to the S&P, and comparing it to other sectors' performance relative to the S&P. What I've been seeing has been a persistent negative correlation—meaning that technology has been outperforming, while on average other sectors have been underperforming.

My historical analysis suggests that this is another important signal. And what we've seen in the past is that the stronger this type of negative correlation, the more likely the market is to broaden.

Put another way, the market can't be led only by tech forever.

5. Some other sectors may have strong outlooks from here

If the market's next phase is led by more than just tech, what should we be looking to? History suggests that cyclical sectors—meaning sectors that tend to rise and fall with the broader economy—might be poised to move up to the front of market leadership.

In particular, the 2 sectors that are most sensitive to interest rates—namely financials and real estate—have faced the strongest odds of outperformance in similar periods historically. As the chart below shows, when tech's relative performance correlations have been in the bottom decile of their historical range, as they recently have been, real estate and financials have historically had 70% odds of outperforming over the next 12 months.

Of course, this is not to say that investors should be making any drastic moves to sell out of certain sectors or double-down on others. Most investors are best served by holding a well-diversified portfolio that's tailored to their goals and by sticking with a long-term financial plan.

But for investors worried about a tech bubble, here's what to remember: The current period looks very different from the dot-com bubble. Tech valuations are not at extremes, and earnings suggest that the stocks could still have more room to run. That said, tech shouldn't be the only sector investors own. A broad portfolio—including some exposure to cyclical sectors such as real estate and financials—could be a better approach from here than a tech-only portfolio.