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Tech stocks’ huge gains shouldn’t make investors fear dot-com 2.0, analysts say.
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Key differences, like the profitability of mega-cap tech firms, distinguish today’s hype from 1999.
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“We on Wall Street like to go back and look at the past peril, [and say] it’s going to be exactly the same.”
Tech stocks are flying higher seemingly every day, and the market is brimming with hype over artificial intelligence. It’s leading some analysts to say the stocks notching the biggest gains are way overvalued and in a bubble.
So, are markets in for a redux of the 2000 dot-com crash?
Two decades ago, the internet lit a fire under Wall Street, boosting the stock market with tech-fueled exuberance. Excitement that the internet was going to change everything catapulted tech shares to meteoric highs.
That probably sounds familiar to anyone watching the market today. Substitute the “internet” with “AI” and you get to 2024, and it’s why some experts have been sounding the alarm about a possible dot-com 2.0.
Yet those fears may be overblown, market experts say. There are key differences that distinguish today’s tech hype from the late 1990s, like the profitability of mega-cap tech firms in 2024, as well as the wider financial environment.
Here’s why we’re not in for a repeat of the dot-com crash.
Today’s hype is fundamentally different
For some tech bulls, the hype is real for one clear reason: AI is simply a game changer.
“AI is the biggest tech trend we have seen since the start of the Internet in 1995,” Wedbush’s Dan Ives wrote in an email to the Business Insider. “I have been an analyst since late 90’s covering tech, this is not a bubble it’s the start of the AI Revolution.”
But it goes beyond that. The dot-com crash happened even though the internet was revolutionary. It’s today’s financial backdrop that’s also quite different.
“Bubbles are created in froth,” BMO’s chief investment strategist Brain Belski told the Business Insider. “Just because stocks go up does not mean it’s a bubble. I think people are shortsighted just looking at things like performance because to have a crash means that you need froth and excess.”
That froth and excess has historically been defined by financing, Belski explained. That’s something that was true in the 90s, when finance firms, banks, and brokerages poured money into dot-com companies. The relative dearth of new IPOs marks a big difference between today and the dot-com era.
“Underpinning that entire period was IPOs,” Quincy Krosby from LPL Financial Management said. “I mean, investment banking were beneficiaries of this phenomenon, and it tends to perpetuate itself.”
In the 90s, companies that hadn’t yet generated revenues, profits, or even created a finished product, were charging into the IPO market. Investment banking surrounding the “new paradigm” was booming. Stock prices would triple and quadruple in a day.
“The difference was back then it was a promise,” 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 explained.
“Over the last several years, the vast majority of the Magnificent Seven’s stock return was driven by profit growth, not multiple expansion,” Philip D. Lorenz, senior Equity Analyst at CIBC Private Wealth US, said.
The market has been rewarding the deliverance of those promises of growth: Meta’s stock soared 20% after the company posted a strong earnings report, while Microsoft, Amazon also climbed after posting results for the final quarter of 2023.
“The market this time is discerning,” LPL’s Krosby said. “The market is punishing these companies almost immediately if they don’t deliver.”
A tech pullback isn’t the same as a crash
Even if tech stocks do slip, it’s important to draw a line between a pullback and a market crash.
“We’ve become so binary,” BMO’s Belski said. “If stocks go down, it’s a crash — no.”
The concern that some analysts have raised is that a slippage in the tech sector could metastasize into a larger rout. Which is troubling because tech stocks make up a sizable chunk of the market. One market vet said the stellar gains represent a “speculative orgy” that will set investors up to fail in the next decade.
But that may be the wrong way to look at it.
“Valuation is the worst predictor of future performance in stocks,” Belski said. “And just because stocks go up doesn’t mean they can’t continue to go up.”
It’s also worth noting that tech isn’t the only fuel for today’s market rally, although it is a powerful one. While only 139 S&P 500 stocks, roughly 28% of the index, managed to outperform in 2023 through October, 231 companies (46%) have outperformed since then, Belski said.
In a note on Tuesday, Belski and BMO’s Nicholas Roccanova wrote that even when the S&P 500’s 10 largest stocks fall off their peaks, the index has performed just fine — although the one time it posted a loss when this occurred was in 2001. Still, the data suggests that the bottom 490 stocks in the S&P 500 can sustain gains even if the top tech stocks falter.
Markets want history to be a guide
A big reason for the flurry of dot-com comparisons is that we tend to compare current drives to past trends. Naturally, today’s ascent of tech stocks, the hype, and the valuations make for a potent sense of déjà-vu.
But those comparisons can be limiting.
“I think, typically, we on Wall Street like to go back and look at the past peril, [and say] it’s going to be exactly the same,” Belski said.
Sticking to close to the past script means investors risk missing the nuance and the slight but important differences between the two eras.
“I think people are so fixated on making calls and simplifying analysis of the Magnificent Seven,” he added.
“There are certainly spots of speculation that can be found among tech stocks today,” Lorenz from CIBC Private Wealth said. “But nothing can compare the tech bubble in 2000 where people were quitting their jobs to become day traders and valuing newly minted IPOs based upon ‘eyeballs.'”
Read the original article on Business Insider