Business

A new tech bubble is inflating. Will it blow up?

Posted June 18, 2020 3:21 p.m. EDT

— There has been a furious rally in tech stocks since the market plunged a week ago.

Apple is near an all-time high. So are tech giants Adobe and PayPal. Recent initial public offerings Zoom, Cloudflare and Peloton are at record levels as well. The Nasdaq is a hair's breadth from busting through 10,000 again.

Call it irrational exuberance, Part Deux. Former Federal Reserve chairman Alan Greenspan used that term in a speech nearly a quarter-century ago to describe the 1996 boom in the stock market -- particularly the rise of big tech stocks and the wave of unprofitable internet IPOs.

This year's tech rally is indeed eerily reminiscent of that late 1990s and early 2000s period, when the Nasdaq surged past the 3,000, 4,000 and 5,000 levels in a matter of months before finally peaking -- and then crashing in April of 2000.

So are we doomed to repeat history?

Techs took a big tumble in March with the rest of the market. The Nasdaq plunged more than 32% between February 19 and March 23 before bottoming.

Stocks have recovered following the Covid-19 outbreak thanks to numerous stimulus initiatives from the Fed and Congress aimed at helping consumers and businesses kicking in and the gradual reopening of the economy.

But the rapid rebound from what some have dubbed the Great Lockdown is raising some eyebrows with grizzled market veterans, especially since so many IPOs and other money-losing new listings like Virgin Galactic and DraftKings are inexplicably surging.

Dash for trash...Chapter 11 stocks are soaring

Making matters worse, bankrupt companies like Hertz have also rallied after filing for Chapter 11 protection. That might be the most egregious example of 2020 irrational exuberance.

"Investors are bidding up some of the worst performing companies just because they believe the current policies will keep them afloat," said Hussein Sayed, chief market strategist at FXTM, in a report Thursday.

"This is leading to the creation of a big bubble in asset prices and the further it grows, the more damage it will make when it bursts," Sayed added.

Investors may have become too complacent, expecting the Fed and Congress to keep coming to the rescue with ever more stimulus. And there are concerns that these programs help Wall Street but have no positive spillover for Main Street.

"The risk of an asset bubble bursting has risen significantly," said Cailin Birch, global economist at The Economist Intelligence Unit, in a report Thursday.

"The Fed has committed to continuing its effort to prop up corporate debt markets," she added. "However, if the real economy does not improve alongside it, this could widen the gap between financial markets and the real economy even further, prompting an asset price crash."

Big Tech holding up entire market

There are some notable differences between now and 20 years ago, of course. The largest tech companies -- Apple, Microsoft, Amazon, Google owner Alphabet and Facebook -- are now all extremely profitable market leaders.

Some might argue that they are too dominant, which raises the specter of further antitrust crackdowns from Washington. In fact, wariness of Big Tech might be one of the few areas of bipartisan agreement.

So tech companies -- and hence their earnings and valuations -- could be under pressure after the election, regardless of whether Donald Trump wins a second term or presumptive Democrat candidate Joe Biden is elected president.

That's bad news when you consider these five tech companies are collectively worth nearly $6 trillion -- about 25% of the S&P 500's overall value. It means just a handful of stocks can sway the broader market, and all the passive index funds that many investors own.

"Much of the market can be characterized as being in bubble territory," said Vitali Kalesnik and Ari Polychronopoulos, analysts at money manager Research Affiliates, in a report this month.

They pointed out the valuation difference between growth companies and value stocks, as measured by book value and stock price, is the widest it has ever been.

"Value stocks tend to be out of favor with investors, while growth stocks tend to be popular and well loved by investors," the analysts wrote. "Bubbles tend to be periods of extreme mispricing."

Something has to give.

So unless more cyclical sectors like banks, energy and health care take the baton from tech, the risk of a tech and speculative growth stock bubble popping as it did in 2000 increases by the day.

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