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This Tech Bubble Is About to Burst

Investor Insights:
  • Last month, investors piled into high-risk, overvalued tech stocks.
  • This narrow buying created a bubble … and the bubble’s about to burst.
  • One chart shows why you need to sell stocks before it’s too late.
 
This Tech Bubble Is About to Burst

In April, stocks had their best month since January 1987. The Nasdaq 100 Index was among the best performer, with a 15.2% gain.

But as odd as it sounds … that’s a potential problem for investors.

Nasdaq 100 stocks are tech darlings, boasting the biggest names in tech. Members include Facebook, Amazon, Apple, Netflix and Alphabet, a parent of Google.

These are the FAANG stocks. They led the stock market rally in 2018. In fact, they led the bull market that started in 2009.

That’s why many investors saw recent selling as a chance to buy FAANGs. But one chart proves that they only helped inflate the bubble … and that it’s going to burst soon.

Proof That April’s Rally Was a Tech Rally

The chart below compares the Nasdaq 100 with the S&P 500 Index.

By the end of the month, 47% of Nasdaq 100 stocks were in long-term uptrends. That’s defined as closing above their 200-day moving average (MA).

Just 20% of the stocks in the more diversified S&P 500 were above their 200-day MA.

Nasdaq 100 Uptrends vs S&P 500 Uptrends

Investor Insights: Last month, investors piled into high-risk, overvalued tech stocks. This narrow buying created a bubble … and the bubble’s about to burst. One chart shows why you need to sell stocks before it’s too late.

This confirms that April’s buying was narrow. Investors focused on high-risk, overvalued tech stocks.

The price-to-earnings (P/E) ratio of the FAANG stocks is about 46. That’s on a weighted basis. This is well above the S&P 500’s P/E ratio of 18.

High P/E ratio stocks do well when companies grow fast. But FAANG stocks aren’t likely to grow earnings.

In recent earnings announcements, management at Apple and Netflix told analysts they could not provide guidance for the next quarter.

Facebook, Amazon and Alphabet warned of lower-than-expected earnings because of higher-than-expected costs.

Only Netflix offered a bullish outlook for 2020.

Prepare for the Next Downturn

Uncertainty is high, as are valuations, in the stocks that investors are buying.

This isn’t the foundation for a sustained rally in the stock market. It’s the typical “buy the dip” trading commonly seen after sell-offs.

This time, the buying is confined to tech stocks — and that’s a problem. Narrow buying is an indicator of bubbles where investors focus on just a few stocks, ignoring fundamentals and business conditions.

That’s bearish. Investors should use recent gains to raise cash so they can avoid losses in the next downturn.

Regards,

Michael Carr, CMT, CFTe

Editor, Peak Velocity Trader

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