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Tech Bubble 2017: Are There Legitimate Concerns? [GUIDE]

Tech Bubble 2017: Are There Legitimate Concerns? [GUIDE]

Posted On July 7, 2017 7:50 pm
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If there’s one major source of instability presently in the stock market, it appears to be coming from this year’s fastest growing industry: technology stocks. In a divergence from the rest of the market, the technology-heavy Nasdaq 100 saw losses in late-June that were twice as severe as the S&P 500, according to this Bloomberg chart.

There are a number of explanations for the weakness of tech stocks relative to other sectors, ranging from some immediate disappointments for major firms to more deep-seated weakness in the industry. The important question here is whether the downturn is the result of lost confidence from short-term factors like Google’s antitrust penalties in Europe, or if there’s a bubble in the tech sector that is finally bursting.

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Although it’s impossible to be sure which explanation is closer to the truth — until more time has passed — the evidence that’s available suggests that the tech industry’s troubles are more fleeting in nature than they were when the dot-com bubble crashed in 2000. The leading companies in the sector are more secure financially than they were in 2000, and the losses they experienced in June are relatively shallow in comparison to the rapid growth that technology companies have enjoyed in 2017.

Furthermore, while the growth of the technology sector may exceed that of other parts of the economy, the stock market in general has performed very well in the first half of 2017, which also suggests that the tech industry’s success is not exceptional enough to raise concern. That said, there are some legitimate concerns regarding the sector’s performance in June that warrant close attention, and the immediate troubles seem to be legal ones, most of them involving the European Union.

Google’s EU Troubles Are Symptoms of Larger Problems

On June 27th, the European Commission exacted a 2.4 billion euro ($2.7 billion) fine for violation of the EU’s antitrust regulations. The report cited the search engine’s tendency to direct users to the company’s own shopping platform while relegating competitors to less prominent places in their search results. This “denied other companies the chance to compete on the merits and to innovate,” as well as denying consumers “a genuine choice of services and the full benefits of innovation.”

The results have been costly for Google, whose parent company Alphabet Inc. saw its stock lose 5.8 billion dollars in the days following the fine announcement. More broadly, the news also proved painful for the technology sector, with Nasdaq losing nearly half a point and Facebook losing a full percentage point in value in a day.

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That said, these are manageable losses, which suggests that investors don’t find them overly worrisome by themselves. In any case, speculation of a new tech bubble and market insecurity has been brewing since the start of the summer. So an antitrust announcement from the end of June can only be a part of the explanation for the current instability.

Of course, Google’s current legal woes in Europe also need to be understood in the context of a broader European crackdown on anticompetitive practices by American companies. Google itself is also facing accusations of placing unfair restrictions on Android manufacturers and mobile network operators, as well as an investigation into the company’s advertising service. Similarly, Facebook and Amazon are also facing antitrust charges from EU regulators, and Apple stands accused of owing 13 billion euros ($14.7 billion) in back taxes to the Irish government.

The EU’s antitrust regulators deny accusations that American companies are being disproportionately targeted by this litigation, but it’s hard to avoid the conclusion that tech companies are facing significant legal issues in Europe, likely a contributing factor to the volatility of tech stocks.

Is This the Dot-Com Bust All Over Again?

In judging whether there is a bubble in the tech sector, it’s important to place the losses into perspective. Tech prices lost 2.6 percent in June, but that number is dwarfed by the meteoric growth in 2017 as a whole, where stock prices have risen 16.6 percent since the start of the year, making them the best-performing sector in the economy so far this year. A look at the performance of the Nasdaq Composite shows that the losses so far could well be mistaken for a blip

Taken in this larger context, tech stocks may appear to be a sound investment regardless. And there are some reasons to believe that the industry is on firmer ground than it was on the eve of the dot com crash. For one thing, stocks are cheaper now than they were in the heyday of dot com startups. And for another, the leading companies in this sector have much healthier balance sheets than they did in 2000, with the top five companies holding eight times as much cash now.

In their assessment of the leading firms in the industry, Goldman Sachs analysts noted that “Steady sales growth, rising cash balances, and limited market shocks have limited-realized volatility [and] now look more like consumer staples than tech stocks.” In other words, the tech industry is performing so well that the old stereotype about the sector’s dangerously-high price-earnings ratios may not apply anymore.

This does not, however, alleviate all potential concerns about the sector’s health. Goldman analyst Robert Boroujerdi sees two problems: the first, lower profitability than in 2000. The second issue is that, just like in 2000, the top five firms in the tech industry have a disproportionate effect on the market. These five companies make up 13 percent of the market value in the S&P 500, compared to 16 percent in 2000. By the same measure, the FAAMG (five top-performing tech firms in the market) companies make up 43 percent of Nasdaq’s value. As far as the market’s health goes, there may still be too much capital concentrated in this small subset of firms.

Are Some Investors Seeking Greener Pastures?

If tech stocks have performed well in 2017 generally, then that also needs to be understood in the context of a larger bull market. In the past six months, the Dow and S&P 500 have posted their biggest gains in four years, with Nasdaq turning in its best performance since 2009. While technology stocks have driven a significant portion of this growth, other industries have also been booming. One notable example is the healthcare industry, whose shares are up over fifteen percent this year, rivalling the growth in tech stocks.

While the first half of this year has been a good one for healthcare in general, June saw the industry continue to reach new heights even as technology stumbled. This seems to be a market response to recent political developments, as investors have taken heart from the contents of the Senate’s healthcare reform bill.

This rally has affected insurance companies like Aetna and UnitedHealth Group. However, it’s been felt most acutely in the biotechnology sector, which grew nearly nine percent in the third week of June alone. Biotech companies are benefiting from the news that the Trump Administration won’t be taking hard action to lower drug prices. If current trends continue, healthcare stocks may end up outperforming technology. This would make it the best performing industry of 2017.

Another area that saw June boosts was the banking industry, which benefited from a Federal Reserve decision giving the go-ahead for 34 major banks to begin stock buyback programs and increase dividends. Keeping in mind the Fed’s decision to raise interest rates, the financial sector can be expected to become more profitable moving forward, and big banks are signaling their willingness to pass that profitability along to their investors. Because of these developments, it’s not surprising that the financial sector seems like it will do well in the coming months, as the effects of the Fed’s monetary tightening begin to be felt.

What Do These Developments Mean for Investors?

What’s most important is for the recent floundering of the tech industry to be put into perspective. Despite a lackluster performance in June, the first half of 2017 has been extremely lucrative for technology companies. The large reserves of cash that the industry leaders are sitting on should insulate them from potential troubles. While talk of a bubble bursting persists, such speculation seems endemic to any episode of feverish growth, as investors question whether such gains are truly sustainable.

As the example of healthcare shows, tech stocks are not alone in their sizeable gains from 2017. It seems unlikely that the entire market will experience a significant contraction in the near future. Therefore, it may be wrongheaded to single out the tech sector for its month of instability. Only time will reveal the true significance of the industry’s difficulties. But in all likelihood, June’s troubles will amount to a footnote in the year’s financial story. And this too, shall pass.

 

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