Are we in a tech bubble?

By Brendan Ellich

For the past few months, the market has traded with volatility that hasn’t been seen in a decade. Since the crash back in March, markets have aggressively rallied with the tech sector reaching all-time highs. In this article we will break down the leading tech companies along with the unprecedented inflow of funds into the industry.

What is a bubble in the market?

A bubble in the equity markets is a situation in which there is rapid escalation of prices followed by a sharp contraction. It is created by a surge in the prices which is not based on the fundamentals of an asset, but rather the speculative views of the market. In 2001, there was a tech bubble known as the Dot Com Bubble, created by excessive speculation in internet-based service companies.

Many of the leading tech stocks belong to the Nasdaq Composite, an index of common stocks listed on the NASDAQ stock market. This market is predominately known to be filled with tech stocks and in recent times, the index has shifted to 53% tech on the back of the recent tech stock rally.

NASDAQ volatility

Although the virus has caused many industries to shut down, the tech sector has held strong with the NASDAQ rallying 59.7% from its March lows. However, the NASDAQ has had its fair share of intraday adversity. One of the days during this rally the index shifted from being up 2% to closing the day down 2% signaling major price swings.

The graph below demonstrates the last time a similar price action was observed, which was the period leading up to the Dot Com Bubble. This can potentially provide us some insight into the future of the tech sector by comparing similar behaviours:

Primary stocks leading tech growth

Tesla

Tesla (NASDAQ:TSLA) is currently the largest automotive car company in the world, with a market capitalization of $276 billion. This is on the back end of an extremely large rally from March lows of $350 per share to the current trading price of $1487. This rally was led by Tesla getting exposure in the media which attracted a lot of new traders around the world. At this current price, many would consider Tesla to be overvalued with a price to earnings ratio of 1047. Many other companies in the NASDAQ are also trading at a high premium.

Amazon

Amazon (NASDAQ:AMZN) is a tech giant with a market capitalization of 1.62 trillion, making it one of the largest companies in the world. Similarly, to other tech companies, Amazon has rallied 50% since March lows. Amazon now trades with a price to earnings ratio of 123 which many would justify based on its recent earnings, which was a catalyst in the share price rally of 6%.

Afterpay

Afterpay (ASX:APT) is the leader of the Buy Now, Pay Later industry, with a market capitalization of 19.66 billion. Although it is small in comparison to the companies above, Afterpay is making a sizeable impact on Australia’s tech industry. Despite its market cap, Afterpay still doesn’t make a profit and thus has a price to earnings of 0. The current valuation of Afterpay factors in speculative gains rather than just the fundamental value of the company. This provides an insight into the current tech landscape and begs the question – is there a bubble forming in the tech sector?

What does this mean for investors heavy in tech?

Currently, it is too hard to say what will happen to the tech industry and whether the gains in the sector are justified due to the impact of the coronavirus. There is no signs of a pop yet, but as always, stocks with strong fundamentals will hold strong in these uncertain market environments. The below charts provide insight into the sizable difference of the tech industry now compared to 2001.

As seen in the graphs, performance is significantly higher as investors are pricing in the potential earnings growth of tech companies as we move into a more digitalized world dependent on technology. On this basis, the tech explosion may be justified as the earnings of tech companies are growing at a much faster rate than the rest of the market.


Disclaimer
The authors of this publication are not qualified to provide financial or investment advice and as such the content provided should not be construed in this manner. All information is intended purely for educational purposes and is provided for the personal interest of UNIT members. The opinions expressed within the article do not reflect those of UNIT as an organisation, its partners or its sponsors.