February 26, 2024

The huge gains of technology stocks are not a new dot-com bubble

  • Technology stocks’ huge gains should not make investors fearful of dot-com 2.0, analysts say.
  • Key differences, such as the profitability of mega-cap tech companies, separate the current hype from 1999.
  • “We on Wall Street like to go back and look at the dangers of the past, [and say] It will be exactly the same.”

Technology stocks are rising seemingly every day, and the market is buzzing with hype about artificial intelligence. It’s leading some analysts to say that the stocks posting the biggest gains are way overvalued and in a bubble.

So are the markets headed for a repeat of the 2000 dotcom crash?

Twenty years ago, the Internet lit a fire under Wall Street, boosting the stock market with technology-driven exuberance. The excitement that the Internet would change everything catapulted technology stocks to enormous heights.

That probably sounds familiar to anyone watching the market today. Replace ‘internet’ with ‘AI’ and you get to 2024, which is why some experts have raised the alarm about a possible dot-com 2.0.

Still, those fears may be exaggerated, market experts say. There are key differences that distinguish the current technology hype from the late 1990s, such as the profitability of mega-cap technology companies in 2024, but also the broader financial environment.

This is why we don’t expect a repeat of the dotcom crash.

Today’s hype is fundamentally different

For some tech bulls, the hype is real for one clear reason: AI is simply a gamechanger.

“AI is the biggest technology trend we’ve seen since the inception of the Internet in 1995,” Wedbush’s Dan Ives wrote in an email to Business Insider. “I have been a technology analyst since the late 1990s, this is not a bubble, this is the beginning of the AI ​​revolution.”

But it goes further than that. The dot-com crash happened while the Internet was being revolutionary. Today’s financial background is also very different.

“Bubbles are made in foam,” Brain Belski, BMO’s chief investment strategist, told Business Insider. “Just because stocks are rising doesn’t mean there’s a bubble. I think people are short-sighted if they only look at things like performance, because a crash means you need froth and excess.”

That froth and excess has historically been determined by financing, Belski explained. That was also the case in the 1990s, when financial institutions, banks and brokers poured money into dot-com companies. The relative lack of new IPOs marks a major difference between today and the dot-com era.

“IPOs were the foundation of that entire period,” says Quincy Krosby of LPL Financial Management. “I mean, investment banking benefited from this phenomenon, and it tends to be self-perpetuating.”

In the 1990s, companies that had not yet generated revenue or profits or even created a finished product stormed the IPO market. Investment banking around the ‘new paradigm’ flourished. Stock prices would triple and quadruple in one day.

“The difference was it was a promise then,” Krosby said.

Not today. Companies like Nvidia, Meta and Microsoft have grown astronomically, yes. But those companies are “rock solid” in terms of their balance sheets, Krsoby explains.

“In recent years, the vast majority of the Magnificent Seven’s stock returns have been driven by earnings growth, not multiple expansion,” said Philip D. Lorenz, senior equity analyst at CIBC Private Wealth US.

The market has rewarded delivering on these growth promises: Shares of Meta rose 20% after the company posted a strong earnings report, while Microsoft and Amazon also rose after publishing results for the final quarter of 2023.

“The market is critical this time,” LPL’s Krosby said. “The market punishes these companies almost immediately if they don’t deliver.”

A tech pullback is not the same as a crash

Even as tech stocks slump, it’s important to draw the line between a pullback and a market crash.

“We’ve become so binary,” BMO’s Belski said. “If stocks fall, it’s a crash – no.”

The concern some analysts have expressed is that a derailment in the tech sector could turn into a bigger rout. That’s troubling because tech stocks make up a significant portion of the market. One market expert said the stellar gains represent a “speculative orgy” that will set investors up for failure over the next decade.

But that might be the wrong way to look at it.

“Valuation is the worst predictor of future stock performance,” Belski said. “And just because stock prices are rising doesn’t mean they can’t keep rising.”

It is also worth noting that technology is not the only fuel for the current market rally, although it is a powerful fuel. While only 139 S&P 500 stocks, roughly 28% of the index, managed to outperform in the period 2023 through October, 231 companies (46%) have outperformed since then, Belski said.

Belski and BMO’s Nicholas Roccanova wrote in a note Tuesday that even when the S&P 500’s 10 largest stocks fall from their peaks, the index has performed well — although the only time it posted a loss when this happened was in 2001. The data shows that the bottom 490 stocks in the S&P 500 can hold on to their gains even as the top tech stocks falter.

Markets want history to be a guide

A major reason for the flood of dot-com comparisons is that we tend to compare current developments with past trends. Naturally, the current rise of technology stocks, the hype and valuations are creating a powerful sense of déjà vu.

But those comparisons can be limiting.

“I think we on Wall Street generally like to go back and look at the danger of the past, [and say] it will be exactly the same,” Belski said.

By sticking to the script of the past, investors risk missing the nuance and small but important differences between the two eras.

“I think people are so fixated on making calls and simplifying the analysis of the Magnificent Seven,” he added.

“There are certainly pockets of speculation among tech stocks these days,” says CIBC Private Wealth’s Lorenz. “But nothing can compare to the tech bubble of 2000, when people quit their jobs to become day traders and value newly launched IPOs based on ‘eyeballs’.”

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