The NASDAQ Composite Index is now trading at its highest level since 2000—when the tech bubble burst. On November 26, 2013, the NASDAQ closed above 4,000 for the first time in 13 years, and is now up roughly 30% for the year, as of mid-December. With stocks reaching dot-com price levels, it’s natural to draw comparisons between then and now. Yet suggestions that we’re entering another tech bubble appear not to be justified—based on a number of factors.
Here are just a few differences that you may want to keep in mind if you are invested in, or are considering, tech stocks.
Earnings growth in technology
Compared with speculative profitability forecasts based largely on irrational exuberance—a primary driver in the lead-up to the early 2000s tech bubble—more realistic earnings forecasts have been a source of strength supporting the tech sector’s current rally to fresh highs.
Consider the chart below, which shows that the technology sector is still trading well below the 15-year average next twelve months (NTM) price-to-earnings (P/E) ratio. This ratio is a measure of how expensive the sector is compared with its forecasted earnings over the next year. The tech sector’s NTM P/E is trading at a multiple of 13.9, which is well below the 15-year average of 22.3, an indication that the sector may be undervalued.
In fact, technology is one of the more attractive sectors relative to most others when viewed through this earnings-multiple lens. This suggests that tech stocks could go up in price while still maintaining their current earnings level, and remain undervalued from an NTM and relative P/E valuation perspective.
|Valuation: Tech vs. other sectors|
|S&P 500 Current and Historical Valuations|
|Sector||NTM P/E||15-Year AVG||Ratio||Relative P/E||15-Year AVG||Ratio
|Source: Strategas, FFAS Capital Markets Group, as of 11/26/2013.|
Tech charts: a different view
Another factor to consider is that the current rise in the NASDAQ has been at a much more measured pace, compared with the dot-com era.
The chart below shows how the tech-heavy NASDAQ completely broke away from the broad market, as represented by the S&P 500, in 1999 and early 2000. The relative strength of the NASDAQ was not confirmed by a coincident rise in the S&P, and tech stocks plummeted soon thereafter.
Tech’s rally during the 1990s was so pronounced that the sector’s weighting in the S&P 500 went from 5% in 1992 to 33% in 2000, before losing about half its value when the bubble burst. While the NASDAQ Composite has outpaced the S&P 500 since the March 2009 bottom, tech stocks have not run nearly as far ahead of the broad market.
Breadth is much stronger now
Finally, a strong argument against a bubble-like environment is that the breadth of the market rally is much stronger now than it was during the tech bubble.
Like the NASDAQ, the S&P 500 is up big year-to-date. However, of the more than 400 points that the S&P is up, the top ten contributors have added just 72 points, or 18%, whereas in 2007 they contributed 65%. Additionally, in 2007, the ten largest contributing stocks were responsible for 116% of the year’s total performance. From a technical perspective, the breadth of the current rally could be a very positive sign.
This applies directly to the tech sector, because many large technology companies are included in the S&P 500. In fact, technology is the largest component of the S&P 500. “Consider Apple (AAPL), which was just a midcap stock in 1997,” says Mark Dibble, senior technical analyst at Fidelity. “Now, Apple makes up roughly 3.2% of the index by itself.”
More important, the breadth of the market’s strength, as a whole, suggests that the rally has not been driven by one segment; thus, there may be a lower probability of a particular segment overheating—like technology did when the bubble burst in 2000.
Clearly, tech stocks are in a different position than they were in 2000. If the market continues to rise, tech stocks may be well positioned to augment the rally.
Dibble adds, “I think the absence of clear, large leadership trends in technology dispels the notion that the current rally is another bubble. Moreover, what some would call two relatively speculative areas of tech—3-D printing and solar power—are small groups with low market caps. This is particularly significant when compared with the size and breadth of the Internet group of the late 1990s—much of which was considered speculative.”
However, there are certainly risks to all stocks—including the tech sector—that should be considered. The potential exists for the market to experience a near-term correction after having posted such stellar performance in 2013, not to mention expectations for Fed tapering (a factor which bit into stocks last week). Moreover, there is certainly no shortage of indicators that suggest investors may be excessively bullish.
Nevertheless, if you are positive on the market and are interested in tech stocks, don’t let comparisons to the dot-com bubble cloud your outlook. After hitting 4,000 on the NASDAQ for the first time since the days when seemingly great things were envisioned for the likes of GeoCities, Lycos, and WorldCom, circumstances appear much different this time around.