Tech Is No Bubble, But the Stock Market Might Be

By James Mackintosh Features Dow Jones Newswires

U.S. technology stocks have finally passed their 17-year-old bubble-era high, and the speed of this year's rally has many -- including me -- concerned. The S&P 500's information-technology sector is up 23%. Of the 10 stocks adding the most market value, eight are tech stocks, when Amazon.com is included. Those who missed out surely regret it.

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But take a step back, and a lot of the gains look more like catch-up than bubble. There might be an everything bubble, but neither tech stocks nor mega-capitalization companies stand out as particularly frothy when looking at performance.

In the past froth was obvious. In the dot-com bubble of 2000 the tech sector produced clearly unsustainable returns -- annualized at 53% including dividends for five years -- that were miles ahead of everything else. In the "peak oil" bubble of 2008 the energy sector had similarly unrealistic five-year annualized gains of 31%.

There's been nothing like this in recent years. It's true that tech stocks have been wonderful for investors this year, particularly the big names of Alphabet, Amazon, Apple, Facebook and Microsoft. But they were mostly just catching up with underperformance in the aftermath of the election, when Silicon Valley was obviously out of favor with the new president, and hopes of tax cuts boosted companies that actually pay U.S. tax.

Look instead at one-year or five-year performance and the tech sector is in line with the financial sector. Or go all the way back to the stock market low of March 2009: Since then financials and tech stock prices have both risen a bit more than 390%, as bank failure risk was priced out; including dividends, real estate, financials and consumer discretionary stocks are all ahead of tech over the period.

It's true that some tech stocks are in other sectors, distorting the measure. Amazon is classed as retail, and its stellar performance generated about a fifth of the consumer discretionary sector's gains since the 2009 low -- and half this year's gains. But the financial sector rally has been about traditional banking and insurance -- not fintech, while real estate is as offline as a stock can be.

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Another way to judge excessive enthusiasm for disruptive companies should be to look at the losers. Old-style retail stocks, owners of U.S. malls and more recently stocks such as Zillow facing rumors of competition from Amazon have all been hammered.

Have they been driven down too far? Taking the gap between the best and worst performing sectors offers a measure of how powerful investment fashions are, and it is wider than usual at the moment. Yet, it doesn't back up the disruption theory.

Over the past year the best sector has outperformed the worst by more than 50 percentage points, the second-widest gap since the recovery from the crisis in 2009. In the 2000 bubble the gap reached 124 points, and in 2008 energy was 66 percentage points ahead of the worst sector (real estate, where the property-price crash was already under way).

Yet, if this wide gap between the best and worst sectors is a reason to worry, it isn't a reason to worry about tech, since financials edged it as the best-performing over the past year, just. The worst performers were telecom, disrupted by an old-fashioned price war, and energy, disrupted by OPEC and shale.

Perhaps enthusiasm for disruption doesn't show up between sectors, though. Amazon is disrupting retail, and new technologies are being deployed in many other sectors too. If investors were betting on the disrupters and against the disrupted, we should expect to see a big gap between the best and worst performers within sectors. We don't.

Tim Edwards at S&P Dow Jones Indices calculates a measure known as dispersion showing how much variation there is in stock performance. Only in the industrial and financial sectors is it higher than the long-run average, and even within consumer discretionary the effect of Amazon isn't visible, with dispersion slightly below average.

I think investors give Amazon and Tesla way too much credit as disrupters, but being overpriced isn't the same thing as being in a bubble. There could be an everything bubble lifting the entire market, but stock performance doesn't suggest over-enthusiastic investors have inflated a tech bubble or even a broader bubble of disrupters. Yet.

Write to James Mackintosh at James.Mackintosh@wsj.com

(END) Dow Jones Newswires

July 20, 2017 13:49 ET (17:49 GMT)