Nasdaq has experienced its best quarter since 1999, recording a 34% astonishing second quarter growth in 2020Q2. The previous best quarter was in 1999Q4 when a gain of 49% recorded. Nasdaq recorded a 500% growth for the years from 1995 to 2000. Comparing it to a similar 5-year period from Aug 2015 to July 2020, Nasdaq achieved 235% gain.

There is a continuous fund flow rotation between traditional value stocks and growth stocks where traditional sector managed to outperform Tech sector on some of the trading days or weeks since the low in March 2020. However, it is not hard to realise the widening disparity between Nasdaq and DJIA/S&P500 indices, where Nasdaq soared much more than the latter two indices. Seemingly, investors are avoiding traditional industries which are hit harder by the ongoing pandemic and treasure growth stocks more, as these stocks are deemed to be more relevant to the new norm, and new economy during the COVID-19 pandemic.

However, recent Tech meltdown from its all-time high put the tech rally into a halt. Given the speed of decline, it makes retail investors recall the dot.com bubble burst in 2000. If history would repeat itself, it is understandable that tech-heavy investors are anxious about the possibility of a tech crash. Similarity between the dot.com bubble and tech stock market in 2020 cannot be understated.

Similarities between 2000 bubble and 2020 rally:

1. Over concentration across the big names – particularly the BIG 5 have been contributing record high allocation of fund since 2000, attributing to more than 20% of S&P 500 in 2020 compared to 18% in 2000 before the dot.com bubble burst. Astonishingly, the combined BIG 5 market capitalisation is larger than the bottom 350 companies in the S&P 500 index.

2. Widening disparity between Nasdaq and Dow Jones Industrial Average (DJIA) – Meanwhile if you look at the indices return since 1990, the stock market tends to succumb to a huge correction whenever there is a huge disparity between Nasdaq and DJIA return. This justifies that market sentiment realises tech’s future is not as rosy as perceived.

Dow vs Nasdaq return since 1971 (source: macrotrends.net)
On top of that, the Nasdaq/DJIA ratio is at an agonising level, as it approaches the dot.com bubble level. This implies that funds are increasingly concentrating in the tech sector.

Nasdaq to Dow ratio (source: macrotrends.net)
This can be described as the “narrowing” phenomenon, a situation where risk diversification is neglected. Over-concentration across the big names also caused deterioration of portfolio diversification in S&P 500, which derive its value based on market cap weightage. Historically, the “narrowing” phenomenon had preceded the Dot.com crash (2000) and Great Recession (2007-2009).

However, although the overvaluation trend in the tech stocks is inevitable, there are some hard facts in today’s Tech environment which could explain why some big names are able to justify its valuation.

1. Proven track record in generating earnings – This is the era where the top few Tech giants’ products and services are deeply rooted in everyone’s daily life. From social media to e-commerce, Tech giants have dominated multiple billion-dollar-industries by either strengthening their own product development, diversifying into new business or by acquiring smaller entitles. As such, IT companies are able to achieve high CAGR in their earnings after the dot.com bubble while back then investors had flocked into the dot.com stock based on overhyped expectation instead of profitability only to find out most businesses in bubble. The chart below shows that Information Technology stock prices were much more aligned to its earnings compared to late 90’s, justifying their valuation and the trend of increasing allocation of funds into IT sector.

IT sector % in market cap and earnings
2. Market sentiment is not as euphoric as late 90’s – While some Tech stocks are benefiting from the COVID-19 pandemic and are not cheap today as a result of valuation boosted by monetary policy , they are not as overvalued as the Tech superstars in 1999. Back then, any IPOs with a counter name ending with “.com” or starting with “e-” had their share price multiplied within one IPO day. Investors were eager to invest at any valuation with mass media advertising on dot.com company. Tech executives allocated huge portion of operating costs on brand building and advertising instead of adding value to their technologies. Today, mega Techs invest in creating future values (e.g. Cloud computing, A.I, 5g and cryptocurrency) and are cash-ready to acquire smaller high-growth businesses. Investors are also more rational to avoid any tech companies that are unable to meet earning expectation (e.g: Alteryx) or lose out to their competitors (e.g. Intel).

3. Robust cash position to establish strong economic moat – With a high cash reserve in their balance sheet, these companies invest heavily in new technologies to ensure they will never run out of steam in exploring opportunities. Facebook (FB), Amazon (AMZN), Apple (AAPL), Microsoft (MSFT); and Alphabet (GOOG) (formerly known as Google) (collectively known as FAAMG) spending hundred-millions a year on R&D, which makes it harder for startups or companies from other sectors to break through the barriers and join the competition. On the other hand, FAAMG had been known to exhibit almost a monopolistic competition nature in the industry and causing technology disruption to the traditional industry. Investors got no choice but to jump on the bandwagon, boosting the valuation higher.

4. Fourth industrial revolution – Historically, an industrial revolution not only changes how people communicate, live and work but also alters businesses. New jobs were created during the revolution while some were eliminated. Right now we are in the beginning of new industrial revolution. It is an ongoing revolution era leveraged on digital revolution, evolving human civilisation at an exponential pace. The technologies of this era consists of A.I, autonomous vehicles, robotics, quantum computing, cloud computing, biotechnology, just to name a few. These technologies are capable of blurring the lines between the physical, digital and biological spaces, causing massive disruption in the demand and supply structure, across all industries. Rising inequalities are expected among companies with Tech giants at the forefront runner in leading the revolution as the winners that take all.

Conclusion

Tech stocks are not as overvalued as they were during dot.com bubble, with FAANG’s business models being much more matured. They also established and acquired strong customer loyalty and brand recognition. In addition, Tech companies also spare no expense in investing in new technologies. Given a relatively high CAGR in 5G, cloud computing and A.I than traditional industry, I foresee that the “Tech trend” will continue.

All in all, the dot.com valuation given by investors in the late 90’s priced in information way too advanced into the future, which would have taken years and even decades to realise. While some of the emerging tech stocks tend to possess higher capital loss risk due to positive market sentiment on their growth potential, being selective in picking up tech stocks is one of the key to survive while beating average index returns. Nonetheless, you can diversify your risk by investing in a basket of technology stocks using Technology Exchange Traded Funds (ETFs).

Technology ETFs

Source:
1. https://www.macrotrends.net/2528/dow-jones-vs-NASDAQ-chart
2. https://www.capitalgroup.com/advisor/ca/en/insights/content/articles/tech-boom-no-dot-com-bubble.html
3. https://www.zerohedge.com/markets/market-now-just-5-stocks-sp-now-more-concentrated-top-5-names-then-ever
4. https://www.theatlantic.com/ideas/archive/2019/10/are-we-cusp-next-dot-com-bubble/600232/
5. https://www.weforum.org/agenda/2016/01/the-fourth-industrial-revolution-what-it-means-and-how-to-respond/

Disclaimer
Important Information: This report is prepared and/or distributed by Phillip Securities Research Pte Ltd (“Phillip Securities Research”), which is a holder of a financial adviser’s licence under the Financial Advisers Act, Chapter 110 in Singapore.

By receiving or reading this report, you agree to be bound by the terms and limitations set out below. Any failure to comply with these terms and limitations may constitute a violation of law. This report has been provided to you for personal use only and shall not be reproduced, distributed or published by you in whole or in part, for any purpose. If you have received this report by mistake, please delete or destroy it, and notify the sender immediately.

The information and any analysis, forecasts, projections, expectations and opinions (collectively, the “Research”) contained in this report has been obtained from public sources which Phillip Securities Research believes to be reliable. However, Phillip Securities Research does not make any representation or warranty, express or implied that such information or Research is accurate, complete or appropriate or should be relied upon as such. Any such information or Research contained in this report is subject to change, and Phillip Securities Research shall not have any responsibility to maintain or update the information or Research made available or to supply any corrections, updates or releases in connection therewith.

Any opinions, forecasts, assumptions, estimates, valuations and prices contained in this report are as of the date indicated and are subject to change at any time without prior notice. Past performance of any product referred to in this report is not indicative of future results.

This report does not constitute, and should not be used as a substitute for, tax, legal or investment advice. This report should not be relied upon exclusively or as authoritative, without further being subject to the recipient’s own independent verification and exercise of judgement. The fact that this report has been made available constitutes neither a recommendation to enter into a particular transaction, nor a representation that any product described in this report is suitable or appropriate for the recipient. Recipients should be aware that many of the products, which may be described in this report involve significant risks and may not be suitable for all investors, and that any decision to enter into transactions involving such products should not be made, unless all such risks are understood and an independent determination has been made that such transactions would be appropriate. Any discussion of the risks contained herein with respect to any product should not be considered to be a disclosure of all risks or a complete discussion of such risks.

Nothing in this report shall be construed to be an offer or solicitation for the purchase or sale of any product. Any decision to purchase any product mentioned in this report should take into account existing public information, including any registered prospectus in respect of such product.

Phillip Securities Research, or persons associated with or connected to Phillip Securities Research, including but not limited to its officers, directors, employees or persons involved in the issuance of this report, may provide an array of financial services to a large number of corporations in Singapore and worldwide, including but not limited to commercial / investment banking activities (including sponsorship, financial advisory or underwriting activities), brokerage or securities trading activities. Phillip Securities Research, or persons associated with or connected to Phillip Securities Research, including but not limited to its officers, directors, employees or persons involved in the issuance of this report, may have participated in or invested in transactions with the issuer(s) of the securities mentioned in this report, and may have performed services for or solicited business from such issuers. Additionally, Phillip Securities Research, or persons associated with or connected to Phillip Securities Research, including but not limited to its officers, directors, employees or persons involved in the issuance of this report, may have provided advice or investment services to such companies and investments or related investments, as may be mentioned in this report.

Phillip Securities Research or persons associated with or connected to Phillip Securities Research, including but not limited to its officers, directors, employees or persons involved in the issuance of this report may, from time to time maintain a long or short position in securities referred to herein, or in related futures or options, purchase or sell, make a market in, or engage in any other transaction involving such securities, and earn brokerage or other compensation in respect of the foregoing. Investments will be denominated in various currencies including US dollars and Euro and thus will be subject to any fluctuation in exchange rates between US dollars and Euro or foreign currencies and the currency of your own jurisdiction. Such fluctuations may have an adverse effect on the value, price or income return of the investment.
To the extent permitted by law, Phillip Securities Research, or persons associated with or connected to Phillip Securities Research, including but not limited to its officers, directors, employees or persons involved in the issuance of this report, may at any time engage in any of the above activities as set out above or otherwise hold an interest, whether material or not, in respect of companies and investments or related investments, which may be mentioned in this report. Accordingly, information may be available to Phillip Securities Research, or persons associated with or connected to Phillip Securities Research, including but not limited to its officers, directors, employees or persons involved in the issuance of this report, which is not reflected in this report, and Phillip Securities Research, or persons associated with or connected to Phillip Securities Research, including but not limited to its officers, directors, employees or persons involved in the issuance of this report, may, to the extent permitted by law, have acted upon or used the information prior to or immediately following its publication. Phillip Securities Research, or persons associated with or connected to Phillip Securities Research, including but not limited its officers, directors, employees or persons involved in the issuance of this report, may have issued other material that is inconsistent with, or reach different conclusions from, the contents of this report.

The information, tools and material presented herein are not directed, intended for distribution to or use by, any person or entity in any jurisdiction or country where such distribution, publication, availability or use would be contrary to the applicable law or regulation or which would subject Phillip Securities Research to any registration or licensing or other requirement, or penalty for contravention of such requirements within such jurisdiction.
This report is intended for general circulation only and does not take into account the specific investment objectives, financial situation or particular needs of any particular person. The products mentioned in this report may not be suitable for all investors and a person receiving or reading this report should seek advice from a professional and financial adviser regarding the legal, business, financial, tax and other aspects including the suitability of such products, taking into account the specific investment objectives, financial situation or particular needs of that person, before making a commitment to invest in any of such products.
This report is not intended for distribution, publication to or use by any person in any jurisdiction outside of Singapore or any other jurisdiction as Phillip Securities Research may determine in its absolute discretion.

IMPORTANT DISCLOSURES FOR INCLUDED RESEARCH ANALYSES OR REPORTS OF FOREIGN RESEARCH HOUSES Where the report contains research analyses or reports from a foreign research house, please note: (i) recipients of the analyses or reports are to contact Phillip Securities Research (and not the relevant foreign research house) in Singapore at 250 North Bridge Road, #06-00 Raffles City Tower, Singapore 179101, telephone number +65 6533 6001, in respect of any matters arising from, or in connection with, the analyses or reports; and (ii) to the extent that the analyses or reports are delivered to and intended to be received by any person in Singapore who is not an accredited investor, expert investor or institutional investor, Phillip Securities Research accepts legal responsibility for the contents of the analyses or reports.

If Distribution is to Australian Investors This report is produced by Phillip Securities Pte Ltd and is being distributed in Australia by Phillip Capital Limited (Australian Financial Services License No. 246827). This report contains general securities advice and does not take into account your personal objectives, situation and needs. Please read the Disclosures and Disclaimers set out above. By receiving or reading this report, you agree to be bound by the terms and limitations set out above. Any failure to comply with these terms and limitations may constitute a violation of law. This report has been provided to you for personal use only and shall not be reproduced, distributed or published by you in whole or in part, for any purpose. If you have received this report by mistake, please delete or destroy it, and notify the sender immediately.