While tech stocks’ dominance rings warning bells for anyone who lived through the crash of 2000, the sector’s ascent has its virtues, and is in some ways a sign of the market’s health.
Don’t look now, but technology companies are exerting more control over the U.S. stock market than any time since the internet bubble.
Fueled by three-year rallies in which Microsoft and Alphabet doubled, Amazon.com tripled and Facebook surged fivefold, computer and software stocks have increased to almost 21 percent of the S&P 500 index’s value, near a 15-year high.
The distance between tech and the next-biggest group, banks, is close to the widest ever.
While the divergence rings warning bells for those who lived through the 2000 crash, tech’s rise has its virtues, and is in some ways a sign of the market’s health.
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For one, it reflects the diminishing influence of banks, which held a much larger share of the S&P 500 in the years before the financial crisis. It’s also evidence of rationality: Tech is one of the only industries where earnings continue to expand.
“The underlying economy is moving more toward technology, so to have it make up a bigger part of the market is probably not a disconnect,” said Brent Schutte, Milwaukee-based chief investment strategist of Northwestern Mutual Life Insurance’s wealth-management unit. “This is not me saying that technology is cheap,” he said. “It’s just taking away that argument that this is a bubble waiting to happen.”
Swelling in the market’s largest group comes amid warnings from bears such as billionaire investor George Soros that stocks are at risk for a repeat of the 2008 crisis. While widening valuations and demand for safety trades such as utilities and low-volatility shares have stirred anxiety, the resurgence in tech shows one cornerstone of the seven-year bull market is behaving as it normally does.
The Nasdaq composite index and S&P 500 information technology index have both rallied 23 percent since markets bottomed in February.
Semiconductor companies like Nvidia, Applied Materials and Micron Technology have led the S&P tech gauge, while only one of its 68 members, First Solar, is down. The Nasdaq closed at an all-time high on Aug. 15 and has climbed for nine consecutive weeks, the longest since 2009.
Tech companies are extending leadership at the fastest rate in four years. Their representation in the S&P 500 has increased by more than 1 percentage point to 20.9 percent this quarter, about 5 percentage points higher than financial shares.
From Apple to Microsoft, mega techs now occupy half the top 10 spots in ranks of the most valuable American companies, matching the number at the peak of internet mania.
Unlike the dot-com era, when investors snapped up web companies with promise but little profit, today’s gains are built on earnings, driven by demand for products such as Apple’s iPhone and Google’s web ads.
While third-quarter growth estimates just turned negative for the S&P 500, the tech group is expected to expand profit by 2.8 percent.
Expanding earnings have helped keep valuations in check. While faltering profits have driven up the S&P 500’s price-earnings multiple to 18.6, the highest level in more than a decade, computer and software companies are trading at a ratio that’s 11 percent below their 20-year average.
At 18 times forecast income, the industry is valued at a discount to the market.
“If tech gets to the point where they’re not growing at all, then it would be really a red flag — that would signal one of the strongest and fastest-growing areas of the economy is stalled out,” said Curtis Holden, a senior investment officer in Houston at Tanglewood Wealth Management. “There is probably some realization in the market that ultimately for stock values to go up, there’s got to be some growth, and tech has a little bit of edge.”