The NASDAQ is Zooming to new highs. Can it last? 

Technology stocks had already been on a good run. From the bottom of the Financial Crisis on March 9, 2009, through the end of 2019, the NASDAQ 100 Index, which is made up of primarily U.S. technology-related stocks, returned 842.8 percent, versus 498.5 percent for the more broadly diversified S&P 500 Index. The outperformance was founded in the latest boom of technology and fueled by the rise of social media, cloud-based technology, e-commerce, and advancement of mobile devices.

Then came the COVID-19 global pandemic, which triggered social distancing measures and forced people indoors, which translated to more time on devices and on the internet. This dynamic uniquely positions the technology sector for supercharged growth through e-commerce, telecommuting, and shifting even more activities online. And once again the NASDAQ 100 is outperforming the S&P 500 — 28.5 percent vs. 3.5 percent — in 2020.

click to enlarge Tim Ellis
  • Tim Ellis

Zoom Video Communications could be a poster child for this growth spurt, as I am confident that most of us have participated in a virtual meeting via Zoom during the pandemic. Zoom's paid subscriber base increased 458 percent, compared to one year ago, and therefore, its stock price has increased 629.7 percent in 2020. Although Zoom is well-known because of its recent success and useful technology, it has only been a publicly traded company since April 2019. After this year's exponential stock growth, its stock market capitalization is now $140 billion. For comparison's sake, the century-year-old IBM's market cap is $105 billion. Investors are currently paying approximately $495 per share for a stock that is expected to earn only $2.47 per share. The justification (if any) is continued hyperbolic growth and converting non-paid subscribers into paid subscribers.

This case study may seem like déjà vu. Pundits are striking comparisons of this period of surging technology stocks to the late 1990s tech bubble, which famously burst and set off a bear market recession from 2000 to 2002. However, there are a couple of reasons to not proclaim the current market environment as a tech bubble redux.

First, there is a fundamental justification for the technology outperformance over the past decade and more recently during the coronavirus pandemic — revenue and income growth. This phenomenon is especially true at the top end of the market, where Apple, Microsoft, Amazon, Google, and Facebook reside. Two decades ago, technology sector revenues as a percentage of gross domestic product (GDP) peaked at 8 percent, yet the technology companies' contribution to the S&P 500 market cap soared to 34 percent. Today, technology sector revenues make up 17 percent of GDP, and the technology companies' percentage of S&P 500 market cap sits at 27 percent. Although there are some high-flying outliers like Zoom, the technology companies of today are holding up their end of the bargain with large contributions of revenues, income, and cash flow.

Second, there does not appear to be a mania or air of "irrational exuberance." A bubble is generally characterized by prolonged upside momentum, whereas this stock market saw a significant downturn at the start of the pandemic in February and March, as well as another pullback in late 2018.

Although I am advocating that technology stocks are not in bubble territory, that does not mean they are the most attractive investment for investors. One of the tenets of investing is that past performance is not a guarantee of future results. Often, there is a period of mean reversion where underperforming and more reasonably valued sectors and stocks catch up. In today's environment, that may be economically sensitive sectors, such as materials, industrials, and financials, that stand to benefit from a full economic reopening and post-pandemic recovery. (Sources: Morningstar, Barron's, Business Insider, JPMorgan.)

Tim Ellis, CPA/PFS, CFP, is a senior investment strategist and wealth strategist with Waddell & Associates.

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