A growing chorus on Wall Street is warning an AI-led bubble may be forming. While a near-term pullback can’t be ruled out, we argue this is not Tech Bubble 2.0.
March 7, 2024
Kelly Bogdanova Vice President, Portfolio AnalystPortfolio Advisory Group – U.S.
The S&P 500’s rally since late October 2023 ranks up there with some of the biggest moves within a short time frame in market history, and the index continues to rack up new all-time highs.
The dominance of the so-called Magnificent 7 technology-oriented stocks (Apple, Microsoft, Alphabet, Amazon.com, NVIDIA, Tesla, and Meta Platforms) that are leveraged to artificial intelligence (AI) – especially in the past year – can’t help but harken back to the Tech Bubble about a quarter century ago.
The Magnificent 7 stocks as a group have surged over 80 percent in the past year, whereas the S&P 500 has climbed around 27 percent through Mar. 4, 2024. When the Magnificent 7 and other technology-oriented stocks are excluded from the S&P 500, the gain is a much more modest 10.8 percent.
With such stark differences between tech and non-tech, it’s no wonder we’re starting to get questions about whether tech stocks are getting bubbly again.
The line chart shows the return performance of three U.S. large-capitalisation indexes from 3/6/23 through 3/4/24: The Bloomberg Magnificent 7 Index, S&P 500 Index, and UBS S&P 500 Ex-Tech basket. All three have risen in the past year, but the performance varies widely with Bloomberg Magnificent 7 up 81.3%, the S&P 500 up 26.7%, and the UBS S&P 500 Ex-Tech up 10.8%.
* The Bloomberg Magnificent 7 Index tracks Apple, Microsoft, Alphabet, Amazon.com, NVIDIA, Tesla, and Meta Platforms.
** The UBS S&P 500 Ex-Tech basket tracks the performance of the S&P 500 excluding the Information Technology and Communication Services sectors, plus Tesla and Amazon. Effectively, this excludes technology-related stocks in the S&P 500.
Source – Bloomberg, RBC Wealth Management; data range 3/6/23–3/4/24; price returns (not including dividends)
First, we think it’s important to distinguish between market trends of the past year and the rally that began following the low in late October.
The Magnificent 7 stocks and technology-oriented stocks in general have dominated both periods. But market performance has broadened out since late October.
Financials, Industrials, and Real Estate – diverse economically sensitive sectors – have risen over 20 percent. Their gains are up there with the three sectors boosted by Magnificent 7 stocks: Information Technology, Communication Services, and Consumer Discretionary. Market performance has gone beyond just the Magnificent 7, and we view this as a healthy sign.
The bar chart shows S&P 500 Index and sector returns from the low on 10/27/23 through 3/6/24. The returns from best to worst: Information Technology 32.2%, Financials 28.8%, Industrials 25.9%, Communication Services 25.5%, S&P 500 Index 24.0%, Consumer Discretionary 22.3%, Health Care 18.5%, Materials 18.3%, Consumer Staples 13.5%, Utilities 6.9%, Energy 1.9%.
Source – RBC Wealth Management, Bloomberg; data through 3/6/24; price returns (not including dividends)
Since late October, in addition to AI enthusiasm, the market has been driven by solid Q4 earnings results combined with optimism about 2024 profit growth. It also has been supported by sturdy economic data and declining inflation, along with investor anticipation that the U.S. Federal Reserve will start cutting interest rates at some point this year.
Second, we think it’s important to consider the key differences between the Tech Bubble peak in March 2000 and conditions today.
The combined price-to-earnings (P/E) ratio of the Magnificent 7 is much lower than that of the so-called “Four Horsemen” stocks (Intel, Microsoft, Cisco Systems, and Dell), the group that powered the Tech sector higher back in the bubble days.
Today, the Magnificent 7 trailing 12-month P/E is 38.3x, whereas 24 years ago the Four Horsemen P/E was an extremely pricey 82.7x, according to Bloomberg.
Beyond the Four Horsemen, part of the rally during the Tech Bubble era was fueled by companies with no earnings and some that barely had operational track records. These were dot-com firms that went public practically overnight – and collapsed almost as rapidly.
That’s not the case this go-around. The AI move and rally in other Tech stocks has been fueled by established firms with years of profits in the books, long operational track records, and experienced management teams.
Furthermore, there are valuation disparities between then and now. The S&P 500 as a whole, the S&P 500 excluding the Tech sector, and the five largest stocks by market capitalisation are all less expensive today than they were 24 years ago, as the chart shows.
The bar chart shows U.S. large-cap trailing 12-month price-to-earnings ratios in March 2000 when the Tech Bubble peaked versus today (then versus now). The S&P 500 was 30.7x then vs. 24.7x now. The S&P 500 excluding the Tech sector was 23.1 then vs. 21.2 now. The largest five S&P 500 stocks were 27.5 then versus 22.3 now. In 2003, there was a group of four large tech stocks with the nickname of the “Four Housemen” (Intel, Microsoft, Cisco Systems, Dell) which had a P/E ratio of 82.7. Today, the “Magnificent 7,” the seven largest technology-oriented stocks (Apple, Microsoft, Alphabet, Amazon.com, NVIDIA, Tesla, and Meta Platforms) trade at a valuation of 38.3x price to earnings.
* “Four Horsemen” was the nickname for four large leading technology stocks from 1996–2002: Intel, Microsoft, Cisco Systems, and Dell. “Magnificent 7” is today’s nickname for seven large leading technology-related stocks: Apple, Microsoft, Alphabet, Amazon.com, NVIDIA, Tesla, and Meta Platforms.
Source – Bloomberg Intelligence, RBC Wealth Management, Bloomberg; March 2024 data as of 3/4/24
At this stage, we don’t think this is Tech Bubble 2.0. But this is no reason to throw caution to the wind.
The S&P 500’s surge since late October ranks with some of the biggest moves within a short time frame in market history. We think the market is bound to take a breather at some point and a pullback can’t be ruled out. But precursors of bear markets – lofty investor sentiment and declining market breadth – are not yet in evidence.
Even though valuations are below where they were during the Tech Bubble peak in March 2000, the market is not inexpensive today. Valuations are above average and stretched, in our assessment, and typically don’t stay at such levels for long periods of time.
RBC Global Asset Management Inc. Chief Economist Eric Lascelles estimates that the risk of a U.S. recession is about 40 percent. While this is down from about 70 percent last year, the risk is elevated compared to periods of economic calm. Some leading indicators are still signaling that an economic contraction can’t be ruled out, especially if employment deteriorates and/or inflation becomes sticky or increases.
We think these factors should be reflected by maintaining Market Weight positioning in U.S. equities with a watchful eye on market trends.
This publication has been issued by Royal Bank of Canada on behalf of certain RBC ® companies that form part of the international network of RBC Wealth Management. You should carefully read any risk warnings or regulatory disclosures in this publication or in any other literature accompanying this publication or transmitted to you by Royal Bank of Canada, its affiliates or subsidiaries.
The information contained in this report has been compiled by Royal Bank of Canada and/or its affiliates from sources believed to be reliable, but no representation or warranty, express or implied is made to its accuracy, completeness or correctness. All opinions and estimates contained in this report are judgments as of the date of this report, are subject to change without notice and are provided in good faith but without legal responsibility. This report is not an offer to sell or a solicitation of an offer to buy any securities. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur. Every province in Canada, state in the U.S. and most countries throughout the world have their own laws regulating the types of securities and other investment products which may be offered to their residents, as well as the process for doing so. As a result, any securities discussed in this report may not be eligible for sale in some jurisdictions. This report is not, and under no circumstances should be construed as, a solicitation to act as a securities broker or dealer in any jurisdiction by any person or company that is not legally permitted to carry on the business of a securities broker or dealer in that jurisdiction. Nothing in this report constitutes legal, accounting or tax advice or individually tailored investment advice.
This material is prepared for general circulation to clients, including clients who are affiliates of Royal Bank of Canada, and does not have regard to the particular circumstances or needs of any specific person who may read it. The investments or services contained in this report may not be suitable for you and it is recommended that you consult an independent investment advisor if you are in doubt about the suitability of such investments or services. To the full extent permitted by law neither Royal Bank of Canada nor any of its affiliates, nor any other person, accepts any liability whatsoever for any direct or consequential loss arising from any use of this report or the information contained herein. No matter contained in this document may be reproduced or copied by any means without the prior consent of Royal Bank of Canada.
Clients of United Kingdom companies may be entitled to compensation from the UK Financial Services Compensation Scheme if any of these entities cannot meet its obligations. This depends on the type of business and the circumstances of the claim. Most types of investment business are covered for up to a total of £85,000. The Channel Island subsidiary is not covered by the UK Financial Services Compensation Scheme; the office of Royal Bank of Canada (Channel Islands) Limited is a participant in the Jersey Bank Depositors Compensation Scheme. The Scheme offers protection for ‘eligible deposits’ up to £50,000 per individual claimant, subject to certain limitations. The maximum total amount of compensation is capped at £100,000,000 in any 5 year period. Full details of the Scheme and banking groups covered are available on the Government of Jersey’s website www.gov.je/dcs or on request.
We want to talk about your financial future.