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- The collective valuation of the S&P 500 is at its highest level since the dot-com boom, according to new research from Barclays.
- But the rise in valuation in recent months has largely been due to the appreciation of the biggest tech stocks and a handful of companies that are built around ecommerce, according to Barclays.
- Those companies’ valuation exceeds the index’s peak in 2000 and is 50% higher than their median valuation over the last five years.
- That looks like a bubble, and it could burst when a coronavirus vaccine is released and helps jumpstart the broader economy, said Barclays’ Maneesh Deshpande.
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Collectively, the stocks that make up the S&P 500 are trading at a value not seen since the peak of the dot-com bubble, and you can peg that rise to a similar cause — tech stocks.
While this bubble too may burst, it’s not likely to do so in as dramatic a fashion or have as prolonged an effect, said Barclays analyst Maneesh Deshpande. The tech companies that have driven the rally since the selloff this spring are much bigger, more stable, more mature — and profitable — organizations than those that spurred the dot-com boom, and investors have much more muted growth expectations for them than they did for the dot-com counterparts, he said.
Unlike the dot-com boom, “there’s no sort of really wild optimism here,” Deshpande told Business Insider in an interview on Friday. “The valuations are substantially higher” than they’ve been in the past, “but the downside is not going to be that substantial.”
Still, in a research note on Thursday, Deshpande downgraded the biggest tech stocks — Facebook, Amazon, Netflix, Microsoft, Apple, and Google parent Alphabet, collectively dubbed by Deshpande as FANMAG — to a market weight rating from overweight on the potential that they could be sold off in coming months.
Business financial make money capital trading Valuations are reaching dot-com levels
Deshpande made the comparison to the dot-com era in his research note. The S&P stocks are trading at 18.7 times their expected earnings for the year-long period that begins a year from now. He chose to look at that later timeframe because the near-term earnings of many companies are expected to be poor, thanks to the recession, and investors are widely understood to be looking past those numbers.
That ratio of price to year-out earnings for the index is the highest it’s been since 2000, according to Barclays’ research. By contrast, over the last five years, the median ratio for the S&P has been 15.2 times expected year-out earnings.
But those broad numbers obscure the reality that much of that rise in valuation is being driven by the FANMAG stocks and a small group of companies built around ecommerce. That’s different from the dot-com boom, when the S&P benefitted from a much wider spread rise in valuations.
This time around, those select few tech and ecommerce companies — Deshpande dubbed them the “resilient” stocks — are trading at 29.2 times their expected year-out earnings. That valuation exceeds the overall S&P 500’s peak ratio in the dot-com boom. It’s also 50% above the median valuation ratio those stocks have posted over the last 5 years and 25% above their previous high.
“Our worry is that current valuations are quite elevated and in bubble territory,” Deshpande said in his research note. “While a bubbly rally might continue, it could equally burst.”
Business financial make money capital trading Tech stocks have become defensive plays
There are good reasons why the resilient companies’ stocks have performed so well during the pandemic. Most notably, the companies have been able to take advantage of it, gaining market share against their non-digital rivals.
In a normal recession, investors would largely rotate out of growth and cyclical stocks and into defensive plays — companies like consumer staples or healthcare providers that are more insulated from the effects of a downturn, Despande said. But this recession has been unusual because of the degree to which it has shifted consumer spending, boosting the businesses of certain companies that are able to cater to citizens who have been hunkered down in their homes.
Seeing that, investors — particularly everyday ones — have been buying up shares in these resilient companies.
“This time, these guys are the new defensive” stocks, Deshpande told Business Insider.
Business financial make money capital trading A vaccine could poke the bubble
But as good as business might be for those companies, at least relatively speaking, they are looking overvalued, he said. Bubbles can go on for a while, but eventually they deflate, one way or another.
What might pop the balloon this time around is a vaccine, Deshpande said. The widespread release of an effective vaccine would help spur the broader economy, allowing people to return to offices, restaurants, and movie theaters — and to decrease their reliance on video conferencing software, food delivery services, and streaming video providers.
When that starts to happen, investors will likely rotate out of some of the big tech stocks and into some of the cyclical stocks that are likely to see their revenue and earnings start to surge, Deshpande said. Given their relative valuations, those cyclical stocks are likely to look cheap compared with the resilient ones — despite what will likely be similar growth expectations.
“You have to look at valuations” of the resilient stocks, particularly the FANMAG group, he said. “At some point,” he continued, “you have to say this is too much.”
That said, Deshpande isn’t expecting a huge selloff when the rotation comes and the bubble pops. He doesn’t expect a repeat of the dot-com bust, where it seven years for the S&P and the Dow to regain their lost ground and 15 years for the Nasdaq.
The dot-com boom was led by a bunch of younger, immature companies, many of which were losing money. That’s just not the case today, Deshpande said. The FANMAGs in particular, which comprise 73% of the market cap of the resilient stocks, are stable and mature, he said.
“These are solid companies,” he said. “There’s no doubt that they’re making money.”
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