The year is 2020. We are still in the middle of a global pandemic, and the U.S. Presidential election is less than one week away. To say that there is uncertainty at this time is putting it lightly.
The VIX Index, which measures volatility, is currently sitting around 40. The higher the number the more volatile the market conditions currently are. Historically, the VIX is typically between 12 and 20. In March of 2020 the VIX Index hit 82, which is the highest it has ever been. Before that, the highest the VIX ever reached was 79 back in October of 2008 during the height of the financial crisis.
So with all of this uncertainty and the VIX higher than the “normal” range, stock market returns should be pretty minimal, right? It depends. Let’s take a quick look at how the three major U.S. Stock Indices have performed year-to-date:
S&P 500: +2.5%
The Nasdaq Index, which is comprised of technology stocks, has far outperformed the S&P 500 and the 30-company Dow Index year-to-date. The outperformance has been so large that some “experts” are calling this another tech-bubble as we experienced back in 2000-2001 when the Nasdaq Index dropped 72% over 18-months and took over 16 years to recover. Let’s look deeper at if this is another tech bubble or not:
Why this could be a bubble:
- The growth of tech stocks is not sustainable, and when we get back to a “normal” environment without the restrictions of COVID, many of these companies will not be reporting the earnings that they currently have. The massive performance in tech stocks is more of a ‘convenience’ surge than a ‘necessity’ surge.
“Before you assume these companies will grow for the foreseeable future, it’s worth considering what the downside could be if life returns to a more normal state in 2021. Will you still be excited to set up a Zoom happy hour with friends and order a burger and fries from DoorDash before an at-home workout on your Peloton (NASDAQ:PTON) bike? Or are you going to cancel your Zoom subscription and go to your local watering hole to hang out with friends again, just like you did in February?” (Motley Fool)
- Tech stocks have had similar performance this year compared to before the 2000 crash.
- Rapidly falling Gross Domestic Product (GDP) of -5% in the first quarter of 2020, and -31.4% for 2Q 2020. As stimulus money runs out and businesses start closing doors this could be even more detrimental to GDP and could potentially lead us into a depression (defined as an extreme recession that lasts three or more years, or which leads to a decline in real GDP of at least 10%).
Why this isn’t a bubble:
- When you look at the performance of the tech sector this year, it is being propelled by some of the largest and most profitable companies of today (Apple, Amazon, Netflix, Facebook, etc.). Comparing this to the tech bubble at the turn of the century, which was mostly comprised of young startup companies that did not have strong earnings, makes the current market environment a hard comparison to the tech bubble of 2000-2001.
“The rise has mainly been from companies that stand to profit hugely from a world that has a ‘phase shift’ to a more digital, less physical world – Zoom, Amazon, Microsoft, Netflix, Apple all benefit hugely, as do the Covid drug and healthcare companies whose shares have rocketed.” (The Guardian)
- The performance of tech stocks over the last five years has not been anywhere near the 5 years preceding the tech bubble in 2000-2001.
Looking at four of the top-performers during each time-period lays out the differences even further:
- COVID has changed the world and the way people think substantially. Do you think that with just a flip of a switch everything is going to re-open and nobody will wear a mask or be afraid to shake hands with a stranger? Like it or not, the effects of COVID are here to stay and it could be a long time before people “forget” and feel comfortable again. This change of mentality means that the modern-day-conveniences of technology could be here to stay in the long-run.
There are strong arguments both ways, but the fact of the matter is that in 2000-2001 we were not in the middle of a global pandemic. You can try to find similarities and differences but these are two completely different market environments. The most prudent approach is to have a well-diversified portfolio so that even if there is a ‘bubble’ in tech, all of your portfolio is not exposed to one sector. Proper diversification not only helps limit downside risk, but it also has historically shortened the length of time for the recovery. It took the Nasdaq Index over 16 years to recover the losses from the tech bubble. It took the S&P 500 approximately three years to recover from the 2008-2009 Financial Crisis.