Technology stocks’ irrational exuberance
By Ryk de Klerk
CAPE TOWN – The risk of investing in tech stocks is ticking up and may weigh on equity markets in general. Global growth stocks have been pushed up exuberantly after the major sell-off in March.
Since the end of March, the MSCI World Growth Index is up by 46 and 24 percent in terms of dollars for the year to date. The MSCI World Growth Index is highly correlated with the Nasdaq 100 Index and the latter is up by 49 and 34 percent over the same period.
According to Nasdaq, the Nasdaq 100 Index defines today’s modern day industrials on the forefront of innovation. The holdings of the iShares Nasdaq 100 UCITS ETF, which aims to track the performance of the Nasdaq 100 Index, is dominated by investments in the information technology (48 percent), communication (20 percent) and consumer discretionary (17 percent) sectors.
The largest holdings include Apple (12 percent), Microsoft (12 percent), Alphabet, holding company of Google (7 percent), Intel (2 percent) and Facebook (4 percent).
The mind-boggling performance of growth stocks is in stark contrast to the performance of value stocks – those that are relatively inexpensive with high dividend yields.
The MSCI World Value Index is up by 19 percent since the end of March this year and down by 14 percent since the end of last year. When compared to the current global economic conditions as measured by an equally weighted consumer confidence index of the major economies and economic zones (US, euro area, Japan and China), it appears that the MSCI World Value Index is fairly priced.
The diversion of trends between growth and value started to appear at the end of 2018 and the outbreak of Covid-19 led to the final decoupling. Consumer behaviour and the way businesses operated changed dramatically due to the coronavirus.
That, together with innovation and the rapid change in information technologies and especially communications warrants longer-term outperformance of growth stocks compared to value stocks. It is exactly the opposite of what happened after the dotcom bubble in 2000 when value stocks reigned supreme during the global economic expansion from 2003 to 2007.
The superior growth prospects of growth stocks compared with the broad market indexes over the past few years was aptly priced in as the Nasdaq 100’s Shiller PE10 – price-to-earnings ratio based on average inflation-adjusted earnings from the previous 10 years – was consistently about 40 percent higher than that of the US market as measured by the S&P 500 Index from 2016 to March this year.
When compared to the MSCI World Index in terms of dollars as proxy for global equity markets, the Nasdaq 100’s valuation was consistently about 40 percent higher than that of global markets over the same period.
The indiscriminate buying and exuberance of growth stocks since March resulted in a further re-rating of more than 20 percent of the Nasdaq 100 index compared with the US market and MSCI World Index.
It is extremely difficult to determine what premium that you have to pay for growth. I am of the opinion that the massive re-rating of the Nasdaq 100 Index and therefore growth stocks is not sustainable and that the famous term “irrational exuberance” is applicable.
According to Investopedia, it was popularised by former US Fed chairperosn Alan Greenspan in a speech in 1996 addressing the burgeoning internet bubble. The current circumstances are not too dissimilar.
A major shake-out is looming. The price levels of value stocks in general are in line relative to the underlying global economic situation as measured by consumer confidence. The exuberant valuations of growth stocks are distorting stock market index valuations.
A shake-out in growth stocks will therefore dent investor sentiment and will rub-off on value stocks as well. It is anybody’s guess when the shakeout in growth stocks will happen.
On Friday, the Nasdaq 100 Index tested a major upward trend line. I do not know whether it will hold or when it will be broken. Stock market risk has increased significantly with the exuberance in growth stocks. With value stocks more reasonably priced, the big pay-day for value-orientated fund managers is looming.
Ryk de Klerk is analyst-at-large. Contact [email protected] His views are his own. Consult your broker and/or investment adviser for advice. Past performance is no guarantee of future results.