Editors’ note: MarketMinder doesn’t make individual security recommendations. Any company mentioned below serves only to illustrate a broader investment theme we wish to highlight.
Is Tech getting too big for its britches? Many note the Tech sector and Tech-like industries’ swelling share of S&P 500 market capitalization and see 1999’s dot-com bubble inflating all over again. At first blush, maybe this seems sensible. Tech has led the bull market that began in March. It led in the downturn and in the preceding bull market. Big returns plus big market cap share may hint at froth. But this surface-level look doesn’t hold water, in our view. A look at fundamental drivers reveals faults in the comparison, suggesting to us Tech’s big share doesn’t reflect an unsustainable bubble.
Tech and Tech-like behemoths do comprise a record-high share of US markets—in a sense. The Tech sector currently amounts to 28% of S&P 500 market cap.[i] While that isn’t quite the 35% share at 2000’s tech-bubble zenith, comparing Tech now and then isn’t quite an apples-to-apples exercise.[ii] The way the S&P 500 classifies stocks is a bit different today than two decades ago. For example, index providers place bookseller-turned-everything-store Amazon in the Internet & Direct Marketing Retail industry within the Consumer Discretionary sector. Several other giants moved recently from Tech to the newish Communication Services—lumped together with the sector formerly known as Telecommunications Services. Tech and these two groups account for nearly 40% of S&P 500’s market cap, exceeding Tech’s 2000 heyday—and spurring many claims the sector is overinflated.[iii] Some even argue a single sector’s exceeding 20% of the S&P 500’s market cap, like Financials in 2006 or Energy in 1980, spells its downfall. The fact Tech (in its broad sense) is now twice that, the thinking goes, means double trouble.
But the claim Tech today is a bubble about to burst falls apart once you start comparing then and now. What doomed Tech in 2000 was expectations zooming ahead of anything reality could ever deliver over the next 3 – 30 months—not surging market values by themselves. In our view, what sets markets up to move most is the gap between reality and expectations. In March 2000, sentiment was stratospheric. Price-to-earnings (P/E) ratios aren’t generally predictive, but at extremes they can be telling. A sign mania was brewing: When Tech’s P/E spiked—more than doubling from 1998 to 2000—as prices skyrocketed while its earnings outlook didn’t.[iv] Similarly, margin debt soared 75.4% in the 12 months to March 2000, showing a rise in speculative behavior.[v] Confidence surveys like the Conference Board’s and the University of Michigan’s were at record highs.[vi] The American Association of Individual Investors’ survey showed a record percentage of respondents were bullish on stocks—and the widest gap on record between the share of bulls and bears.[vii]
Taken in isolation, none of these gauges would prove anything. But in concert, they illustrate the day’s euphoria—which blinded investors to a deteriorating reality. At a more qualitative level, many were convinced the “new economy” had obliterated quaint notions like economic cycles. They bid up IPOs of firms with little cash, weak revenue and no prospect of turning a profit. They dismissed those factors by noting new metrics like “clicks.”
While there may be pockets of speculative excess now, today’s market doesn’t look like then. There are occasional misses and stumbles by select firms, but Tech overall continues meeting and exceeding expectations. Their earnings heft mostly matches their market-cap weight: Tech and Tech-like stocks’ share of S&P 500 earnings is on track to exceed 30% this year.[viii] Not only that, their earnings and revenues are among the fastest growing. People use their services extensively in exchange for good, hard money—not clicks or attention. These are hardly the fly-by-night dot-coms of yesteryear. Rather, they are some of the world’s most profitable companies—with the strongest balance sheets.
Despite this, critically, sentiment toward Big Tech ranges from wary to mildly optimistic, in our view. High profile regulatory scrutiny in the US and abroad seems to make headlines daily—as it has for years—spooking some investors. When a September selloff hit Tech hardest, many pundits hyped it as the beginning of the end—not the “buying opportunity” logic you would likely hear if markets were broadly frothy.
Then too, there is no set limit to how big a sector can grow. For one, categorization can be somewhat arbitrary. Just consider our earlier discussion of Amazon. The same applies to several other big Tech-like firms. Also, many nations—even ones with fairly large stock markets—see a tilt toward select sectors. Italy’s Financials weighting is 28%.[ix] Industrials are 21% of Japan’s total market cap.[x] In Emerging Markets Taiwan and South Korea, Tech’s share is 72% and 46%, respectively.[xi] Of course, America has a bigger stock market than these nations. But the broader point still applies: Countries’ weights just depend on their economic makeup—and they ebb and flow over time.
While we don’t think Tech’s big weight is sign of a bubble, we do think it is a reminder of the importance of blending sectors that respond to different drivers. Outside Tech, make sure you own some stocks in value-oriented sectors that act as insurance in the (we think unlikely) event Tech falters.
[i] Source: FactSet, as of 10/28/2020. S&P 500 sector market value weights, 10/27/2020.
[ii] Ibid. S&P 500 sector market value weights, 3/27/2000.
[iii] Ibid. S&P 500 sector and industry group market value weights, 10/27/2020.
[iv] Ibid. S&P 500 Information Technology next-twelve-month P/E, 10/8/1998 – 3/27/2000.
[v] Ibid. Debit balances in margin accounts at broker-dealers, March 1999 – March 2000.
[vi] Ibid. Conference Board Consumer Confidence Index, January 2000, and University of Michigan Consumer Sentiment, February 2000.
[vii] Ibid. AAII Sentiment Survey Bullish Percent and Bull-Bear Market Spread, January 2000.
[viii] Ibid. S&P 500 Information Technology sector plus Interactive Media & Services and Internet & Direct Marketing Retail industry groups expected earnings as a percentage of the total, 2020.
[ix] Ibid. MSCI Italy sector market value weights, 10/27/2020.
[x] Ibid. MSCI Japan sector market value weights, 10/27/2020.
[xi] Ibid. MSCI Taiwan and South Korea sector market value weights, 10/27/2020.
If you would like to contact the editors responsible for this article, please click here.
*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.