Tech stocks have had a nice run lately, as operators like Netflix (NASDAQ:NFLX) and Amazon.com (NASDAQ:AMZN) have posted sizzling returns. But smaller tech stocks have also been standouts.
Just look at the IPO market this year. Even if you purchased many tech stocks after they hit the markets, you would have likely seen strong returns. Some examples include Dropbox (NASDAQ:DBX), Zscaler Inc (NASDAQ:ZS), Docusign Inc (NASDAQ:DOCU) and Zuora (NYSE:ZUO).
So the big question is: Are tech stocks in a bubble?
Well, for the most part, this is a tough question to answer. Often a “bubble” is something that investors realize after there is a huge plunge in asset values. This was certainly the case with the real estate boom that ended in the financial crisis.
Interestingly, there is actually no clear definition of a bubble. It’s really just a term of art. After all, there are many pithy quotes about bubbles. For example, billionaire investor George Soros once noted: “Stock market bubbles don’t grow out of thin air. They have a solid basis in reality, but reality as distorted by a misconception.” Then there is Ken Fisher, who said: “Indeed, bull markets are fueled by successive waves of prior skeptics finally capitulating as their fears fade. Eventually, fear turns to euphoria, and that’s the stuff of bubbles.”
Such statements are certainly insightful. But again, the concept of a bubble is fairly vague.
Yet one way to look at this is by analogy. In terms of tech stocks, this means harking back to the roaring 1990s. The bull market had some major fundamental drivers, including the emergence of the Internet as well as a big-time demographic shift, as the Baby Boomers entered their prime earning years. But there were other factors -– which are generally overlooked -– like the end of the Cold War and the move towards globalization.
All this was fuel for a boom in tech stocks. And the main barometer of this was the red-hot IPO market. Keep in mind that during the late 1990s, there were often 20 to 30 public offerings a week -– with most of them having names ending with .com. It was not uncommon to see these deals post gains of 200% to 300% on their first day of trading.
No doubt, winning in this market was easy. There was little research required. All you had to do was target tech stocks and power up an E*Trade account. Oh, and of course, it did not matter if the company had much revenue.
I had some first-hand experience of the mania. In 1998, I wrote a book on IPOs and it sold like hotcakes. I would often talk to people, who had little investing experience, who were suddenly playing offerings.
But fast forward to today. The environment is nothing like it was during the 1990s. The fact is that investing in tech stocks has not become pervasive across America. Actually, investing in stocks is something that has seen fading interest. According to Gallup, about 62% of the population invested in stocks during 2001 to 2008. But this fell to 54% from 2009 to 2017, largely in reaction to the lasting impact of the financial crisis.
Are Tech Stocks Safe?
Something else: While the current markets are not cheap, they are not at the levels seen in the late 1990s either. Note that the price-to-earnings ratio on the S&P 500 went over 40X during 1999. As of now, it is roughly 25X.
Now this does not mean that tech stocks are safe. If anything, there are signs of overheating. More importantly, there are some potential landmines — such as the rise in interest rates, the moves toward protectionism and the increase in the value of the dollar — that could easily trip up tech stocks.
But as for there being a bubble, there are still not the classic signs of pervasive investor euphoria, which is key to driving valuations to excessive levels.
Tom Taulli is the author of High-Profit IPO Strategies, All About Commodities and All About Short Selling. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.
