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Are we in a tech bubble?

· Ai Investing,Stock Market,Stock Trading,Investing,Tech Investing

Are we in a tech bubble?

On August 2, 2018, Apple became the first publicly listed company to hit a 1-trillion stock market valuation.

Five months later, on January 2, 2019, Apple revised its revenue guidance for its first fiscal quarter 2019, blaming weakness in the Chinese economy and lower than expected iPhone sales. The Dow Jones Industrial Average slumped 660 points, led by the decline in Apple. The S&P 500 was down 2.48% as the tech sector fell 4.7%, and the Nasdaq declined 3%. Apple’s stock price declined from its high of $232 in October 2018 to $148 on January 4, 2018, down some 35% in the last three months.

The decline in the stock market is piling on existing fears of a looming economic slowdown. What should we make of the trend of tech stocks leading the decline in most stock indices? The technology sector makes up roughly one quarter of the S&P 500 today. To understand the magnitude, the Financial and Healthcare sectors are the next two biggest sectors, making up roughly 14% each. Are falling tech stocks a microcosm of a larger financial decline? Or, rather, is the overvalued & underperforming tech sector actually triggering a looming recession?

Apple recently stated that its previously predicted $89bn to $93bn revenue for the first quarter was overestimated, and would instead be closer to $84bn. This, according to Apple, is due partly to an underperforming Chinese economy, less global demand for global iOS device upgrades, which are themselves partly due to the effects of trade wars.

With giants like Apple abruptly lowering revenue expectations, smaller tech companies (like TSMC, who manufacture Apple’s iPhone chips) are following suit, creating a domino effect of falling stock prices throughout the tech industry. When optimism is high, people are willing to pay more for a stock than its fundamental economic value; currently, we may have an asset price bubble forming around tech stocks. This has recently been boosting the economy, but as Apple has warned, revenues may soon become underwhelming, in which case stock prices and investment will fall (the bubble bursts). This is a possible recessionary trigger.

Apple’s current predicament is only one example of a larger problem: the general overvaluation of tech companies. Since the Great Recession, tech stocks have been growing faster than any other industry, helping the US economy experience steady growth for the most consecutive years in modern history. Now, however, tech companies are on track to experience their worst month since the financial crisis. Although these companies deserve credit for being at the heart of the decade-long bull market in U.S. stock prices, too much optimism in the tech sector causes investors to overvalue these companies and set unreasonably high expectations for their performance. The assumption that tech companies will stay on the same track of exponential growth is dangerous if real earnings don’t keep up with expectations.

On top of Apple’s decreased expected revenues, there are other signs that current tech stocks may be overvalued. With recent technological innovation skyrocketing, we may have become desensitized to what are (objectively) mesmerizing advancements: in other words, our expectations are now geared towards an extremely fast standard of innovation. But how rational are these expectations? Moore’s Law is a hypothesis that predicts that the number of transistors on a computer chip will double every two years. Recently, however, chip manufacturers like Intel have been pushing back target dates for releasing more compact chips, widening the gap between development cycles. Perhaps, this is an indication that, contrary to conventional wisdom, advancements in technology are slowing down rather than speeding up.

This is not the first time where our expectations for tech companies have exceeded their actual productive capabilities. The bursting of a tech bubble triggered a mild recession during the early 1980s and, more recently, the dot-com bubble burst in the early-2000s, when everyone was anticipating (too early as it turned out) what the internet would do. What causes our expectations for tech companies to be so often off the mark? We must accept the paradoxical idea that though we are extremely close, and even dependent on the products of these tech companies, most of us are also extremely detached from the engineering behind them. Take a simple industry: the cereal industry. Investors have a pretty good idea of the amount of raw material and labor that goes into the production of cereal, and these inputs are unlikely to change drastically (which is why we will probably never experience a “cereal bubble”). The tech sector, however, is much more complex, and its ins and outs are less likely to be well understood by the average investor. These investors base their expectations on past performance, expecting growth to stay steady, without considering a potential limit to the innovative and productive capacities of the companies they invest in. This paves the way for tech bubbles to form.

It’s too soon to say whether we’re currently in a tech bubble. If it was obvious we were in one, we would have already seen massive disinvestment in the tech sector. We must also confront the following question before establishing any causal relation between the tech sector and the state of the economy: is a general downturn in the economy, or even trade wars, causing tech stocks to drop or, rather, are underperforming tech companies causing this economic downturn? Only time will tell. But if we are in a tech bubble, rest assured: historical evidence shows that recessions following any asset price bubble are much milder than recessions triggered by credit bubbles, like the housing bubble of 2007.

Written by Jeremy Kattan & Edited by Alexander Fleiss

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