Another Tech Bubble is Swelling
Despite two recessions in the past decade, tech stocks continue to strengthen a bull market. But there are signs that it could all crumble.
The economy has evidently not been doing well in the past year, but the stock market has continued to rise. Recently, there have been some strong parallels between now and the dot-com bubble of 2000. This has many market experts worried.
Unjustifiable High Prices
Companies are rushing to go public. The New York Times wrote at the end of 2020: “Initial public offerings, when companies issue new shares to the public, are having their busiest year in two decades—even if many of the new companies are unprofitable.” IPOs have spiked, especially with the hot financial trend of using SPACs to go public. Many of these companies have rapidly growing revenues, but aren’t necessarily profitable. These IPOs have been leading to pricey valuations with no justification.
Valuations themselves are also way off. According to Siblis research, the forward P/E ratio (the price-to-earnings ratio is the relationship between the price of a stock and how much it earns) is at 39.6, meaning that the NASDAQ is trading at 39.6 times earning estimates for the next 12 months. This is much higher than it was in June of 2019, with a P/E ratio of 24.31. In the context of the tech industry, this large jump may indicate that stocks are being overvalued.
This isn’t to say that low interest rates aren’t contributing to these high prices. Low interest rates are a major bullish market driver. It is to be expected that there is a high demand for stocks with such a low interest rate currently in place.
Learn more about The Finch's coverage of special purpose acquisition companies by reading Isabel Zhang's "The SPAC Attack."
Cash Chasing Mentality
There’s also a widespread “get rich quick” mentality that has been driving prices up. Recent events with “meme stocks” such as Gamestop ($GME) and AMC ($AMC) have severely disrupted market speculation. Many investors are ignoring factors such as profitability and performance for the sake of cash chasing and making a “quick buck." Disruptions to market speculations and valuations are driving some companies’ stock prices up without any good justification.
A Cap on Innovation
Tech stocks’ P/E are historically higher because of their “innovation premium." Earnings are more volatile because tech is generally more unpredictable. However, there is a limit to this so-called innovation premium. With a P/E ratio of 39.6, it is not feasible for these tech companies to live up to their high expectations. Innovation can increase earnings, but only by so much. Especially since the tech market is already so saturated and so advanced, it is hard to come up with ground-breaking innovations. Thus, investors should be cautious about these valuations, even in light of tech innovation premiums.
Will it Burst?
These indicators do not necessarily point to the fact that there may be a market crash in 2021. However, tech stocks are currently overvalued, and investors should be attentive. It is only a matter of time before some tech stocks could see major corrections.
Isabel Zhang is a second year at the University of Pennsylvania's Wharton School of Business. She writes about innovation, market regulations, and healthcare.
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