Possible tech bubble brings to mind lessons of dotcom bust4 min read . Updated: 02 Sep 2020, 11:26 AM IST
Use a diversified approach instead of a sector-heavy one, and be mindful of the role stimulus may be playing
Apple Inc., the US-listed maker of iPhones, crossed $2 trillion in market capitalization recently. The Nasdaq, an index dominated by US technology stocks, is up 50% over the past year and has seen a rise of about 20% over the last decade (excluding dividends). A recent chart tweeted by Sunil Singhania, founder of Abakkus Asset Manager LLP, showed that the share of tech stocks as a percentage of the US equity market is close to what it was during the dotcom peak. The Financial Times called it a “K shaped" recovery in an article published on 21 June, with some sectors recovering their previous peaks and others dramatically lower.
The India market has seen a similar polarization over the past three years with the top five stocks accounting for a huge 43% of the benchmark Nifty index and the top stock accounting for 14% of it. The information technology sector constitutes 16% of the Nifty 50, but if we consider Reliance Industries Ltd, with its huge investment in Reliance Jio as a tech company, that weight shoots up to 30%. On 21 August, Reserve Bank of India governor Shaktikanta Das set market participants in India aflutter when he said that there was a disconnect between the stock market and the real economy. According to Das, surplus liquidity was driving up the market and it would correct but he didn’t say when.
To some investors, it may look like the tech bubble is back. In this piece we ask experts to what extent this is true and what investors should do.
There is an argument to be made in support of the tech surge. The shift to online working and interaction has created legitimate enthusiasm for the future prospects of tech companies. “There is polarization in the US and Indian markets. But this is because of the ‘winner-takes-all’ economy. If asked, everyone will remember the world’s largest search engine, but virtually no one will remember or care about the second largest," said Rajeev Thakkar, chief investment officer, PPFAS Mutual Fund.
However, the resulting surge of tech stocks may be out of sync with even improved prospects for IT companies.
When it comes to India, the scenario is a little different. “There are parallels to the 1990s dotcom boom in the sense that some large stocks have unrealistic expectations built into them. I would not necessarily say it’s only tech this time," said Vikas Gupta, CEO and chief investment strategist, Omniscience Capital.
Relevance for India
There are three reasons why Indian investors should take note of the giddy valuations in US tech stocks and the concentration in the Indian market. First, a crash in the US market invariably spreads to India. So watching out for a US bubble is useful for Indian investors.
Second, if Indian large-caps are also stretched in terms of valuations, a similar story is being played out here, albeit at a milder level. “Given how unusual this year has been due to the covid-19 crisis, we look at market cap rather than PE (price-to-earnings) ratio to measure concentration. By this measure, large-cap valuations are at historic highs compared to mid- and small-caps," said Shravan Sreenivasula, director, investment advisory division, Avendus Wealth Management Pvt. Ltd.
The third parallel is one of interest rates. In the 1990s, Greenspan Put supported stock markets in the US. This was basically the idea that Alan Greenspan, then chairman of the Federal Reserve, would cut interest rates whenever there was volatility and support the markets. In today’s scenario, US rates have not only been cut to near zero but the Fed has also injected a $3 trillion stimulus (about 13% of the US GDP) into the economy. Much of that money has flooded into Indian markets, as FII (foreign institutional investor) flows show.
What you should do
So what can investors do to avoid making the same mistakes as their forebears made during the dotcom boom?
First and foremost, avoid sectoral bets. IT was the ruling sector during the dotcom boom. In India, pharma has seen a sharp rally post the covid-19 outbreak, with the Nifty Pharma Index rallying 50% since the start of 2020 (as of 21 August). Other stocks in the news such as Reliance Industries have also seen a huge rally. Investors should not rush into them without doing the homework about the company’s prospects and valuations. “Do not be gung-ho on any one particular sector or theme. Always keep asset allocation and diversification foremost in your mind. The covid crisis has created conditions for tech companies to thrive but be mindful of the kind of expectations implied by high PE levels," said Amol Joshi, founder, Plan Rupee Investment Services.
Second, they should be mindful of the role that interest rates and stimulus programmes are playing. These may not be around permanently.
Third, know the limits of your own abilities in terms of getting in and out of the markets at the right time. “Market cycles move a lot faster than before. The stock market hit a multi-year low in March and bounced back close to its previous high by August. So a correction is likely to be short and steep," said Vikas Sachdeva, CEO, Emkay Investment Managers. A correction may occur, but you may not be able to benefit from it in time. In such cases, a systematic investment plan (SIP) which automatically invests more during market corrections may work best.