Feature Stories | May 02 2024
Fierce rallies in technology related share prices are eliciting calls of a new investment bubble a la Nasdaq 2000, but are such fears justified?
Part One: A bubble or just a “natural comparison” to the dotcom bust?
-A narrow concentration of strongly performing big tech stocks
-This time is same but different?
-Valuations are high but not historically extreme
By Danielle Ecuyer
Much has been written on Generative Artificial Intelligence (Gen AI), not least of which is the cri de cœur of “bubble” with analogies to the 2000 dotcom bust.
The run up in Big Tech or the Magnificent 7 (Apple, Amazon, Google, Microsoft, META, Nvidia and Tesla) over 2023, spurred on by the posterchild of the Gen AI mega trend, Nvidia, which rose 50% in the first two months of 2024 has brought the bears out in force.
The Mag7 delivered an average 100% return in calendar 2023, and numerous factors including the narrowness of the market rally, the technology thematic and the impact of a new secular trend were sufficient for many to draw a comparison to the dotcom boom and bust of the late 1990’s/early 2000’s.
Analysing the ‘bubble’ proposition, Burton G. Malkiel, author of A Random Walk Down Wall Street wrote in Barrons in March, that while the US market is not cheap on a cyclically adjusted price/earnings or CAPE ratio of 34 times, twice the historical average, the ratio is nevertheless still -10 points below the 44 times level in 2000.
Equally, Malkiel highlights the Mag7 are trading at a trailing 12-month multiple of circa 42 times, compared to Cisco (the Nvidia of the dotcom bust) which traded at a triple digit price-to-earnings multiple both on a historical and prospective basis in 2000.
Cisco is often used as the example of a bubble bursting in a secular trend. The stock price fell -90% post its 2000 highs and to this day has not recovered.
In a recent podcast Decoding the Magnificent Seven: Profitability, Fundamentals and the Future, Alan Pullen, Portfolio Manager at Magellan explains the difference between a “natural comparison” and what he refers to as the “fundamentals”.
Although Pullen doesn’t see Tesla as the same fit in the Mag7, he stresses the combined group has generated an average 17% p.a. compound growth in revenue from 2017 to 2024 (including current year estimates).
When combined with the net cash balance sheets, strong cash flow generation and strength of margins, the combined group has produced EPS growth of 21% p.a. over the same period (including buybacks).
As Malkiel highlighted, the valuations on average for the Mag7 at circa 34 times earnings is not cheap but remains favourable in comparable to the dotcom 5 – Cisco, Microsoft, Oracle, Intel, and IBM at 80x prospective earnings and Cisco and Oracle at 120x forward earnings back in the early 2000’s, emphasises Pullen.
Chief Investment Strategist at UBS Investment Bank, Bhanu Baweja explains the correlations between the current investor ‘exuberance’ and the mid 1990’s until March 2000 in the UBS Global Research Pod Hub, How similar is today’s rally to the 1990’s bull run?
His analysis of history divides the US technology bull market into two phases. The first from January 1995, post a robust 300 basis point rate hiking cycle from the Federal Reserve until June 1998. Baweja states that rally was relatively orderly and broad based.
In contrast, the next phase from October 1998 until March 2000 was characterised by an “explosive and narrow move” of technology and cyclical companies.
Baweja draws three similarities between these periods and the recent outperformance of US technology giants:
– the leadership of technology companies
– the narrowness of the rally (the Top 10 stocks underpinned 34% of the S&P return in 2023)
– and the CAPE valuation at 34 times, which is in the 96th percentile and only -10 points below the peak of the dotcom valuations.
On further investigation, Baweja also notes the current cycle is notable for three major differences:
– the quality of the companies leading the rally are far superior in terms of investor returns, profitability and cashflow generation
– the investor exuberance of the late 1990’s leaked into small cap companies
– the IPO market in the late 1990’s registered 475 listing p.a. on average, compared to 133 listing p.a. post covid
It is easy to see how those who only watch the share price charts, could be drawn to the comparison of the last major technology boom and bust.
The excitement and potential impact on economies of a new technology (Gen AI) has clear correlations to the internet era and that of mobile telephony and smart phones.
But as Magellan's Pullen explains, the expected revenue growth for the Mag7 is 11% p.a. compound for the next five years. When combined with efficiency gains and productivity improvements, EPS is forecast to grow 14% p.a. over the same period.
This is a far cry from what Pullen describes as a speculative bubble (dotcom) that ultimately collapsed under its own weight.
Coming next, Part Two of Generative AI, investing in the 21st Century Megatrend takes a deep dive into the size, scope, risks, and potential winners in the Gen AI behemoth trend.
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