Tech stocks may be in a bear market, but don’t worry, a dotcom crash in the making this ain’t. So says Jim Paulsen, chief strategist at The Leuthold Group, who makes a persuasive case for calm in his latest note.
Paulsen kicks things off by noting that while prices for tech businesses are close to where they were back in 2000, earnings today are far more robust.
Earnings per share for the S&P 500 technology sector may have declined somewhat over the past two years, he says.
But they remain roughly 60 per cent above where they were back in early 2000. Tech stocks, it turns out, are actually relatively cheap in historical terms.
Exhibit number two is the broad-based nature of the bull run tech stocks embarked on in the late 90s. Today, of course, a handful of mega-sized companies dominate. “Small-cap tech never fully engaged in the contemporary tech run,” Paulsen says.
The relative price of the S&P 600 Small-Cap Technology index rose to a high just slightly below 1.0x in the current cycle compared to that of 1.7x during the enthusiastic bubble of the late 1990s!
(NGL, we love it when analysts drop an exclamation mark in).
Tech is also far more productive today, Paulsen argues, whether measured in terms of relative sales per employee (chart 4) or relative return on investment (chart 5).
The latter shows how in recent years stocks comprising the S&P 500 tech index have generated a ROE between 15 per cent and 20 per cent higher than that of the broad-based S&P 500. That compares, on a relative basis, with a 5 per cent premium during the 1990s boom. Fundamentals > froth.
Comparing the market cap weighting of the S&P 500 tech index with its economic weighting, or the proportion of nominal GDP that comes from tech sector sales, provides further evidence that technology stocks, while far from cheap, may not be too overpriced.
As Paulsen points out:
“In March 2000, the market-cap weighting of the Tech sector was 34% compared to only a 7.9% weight for total economic activity. The dotcom top involved a stock market in which its leading sector was priced disproportionately above its economic contribution. Today, though, the market-cap weighting of tech to the S&P 500 is only 27.2% versus an economic weighting of 17.5%.
Is the Tech sector as cheap as it has ever been, gauged by its contribution to the general economy? no. Is it grossly overpriced or anywhere close to its relative value compared to the economy in 2000? No!”
A quick glance at forward price to earnings multiples for tech and non-tech stocks going back to 1990 underscores his point.
Although the tech sector remains just above its average relative valuation going back 32 years, it is nowhere close, Paulsen writes, to the “gross overvaluation” that existed between 1998 and 2004, when the sector’s P/E multiple peaked above 50 times.
Today’s bear market in tech stocks is therefore not likely a dotcom redux, Paulsen concludes. Sure, tech could continue to disappoint, especially if growth and inflation remain hot and bond yields keep rising.
But as far as Paulsen’s concerned, the risk of a full-blown tech “collapse” is probably past. Indeed, after a brutal April, the Nasdaq has bounced over the past two days as investors have dipped back in.
For Chase Coleman and Cathie Wood’s sake, we hope he’s right.