- Nasdaq 100 futures held steady this morning after tech stocks neared record highs yesterday. Some analysts are worried there is a bubble in tech, as unprofitable small-cap tech companies are outperforming companies with actual profits on the Russell 2000. Valuations look frothy but could go higher if AI capex increases beyond its already high levels.
Nasdaq 100 futures are unchanged this morning in premarket trading, following a substantial 1.3% gain yesterday that brought the tech-heavy index close to its all-time peak. In contrast, the wider S&P 500 index saw a “only”% increase. The Nasdaq has advanced 20% so far this year. (The S&P has climbed 14.5%.)
TL;DR
- Unprofitable companies on Russell 2000 are outperforming profitable ones, raising bubble concerns.
- Analysts question tech stock valuations, noting many small-cap firms lack earnings.
- AI capex increases could further inflate tech valuations, despite current frothy levels.
- Potential Fed rate cuts and AI sector activity may sustain tech stock gains.
However, on Wall Street, analysts are more frequently questioning if tech stocks are experiencing a bubble, with a key statistic frequently cited: roughly 40% of the firms within the small-cap Russell 2000 index have no earnings or negative earnings, as reported by Apollo Global Management chief economist Torsten Slok. “Something remarkable is going on in the equity market. Stock prices of companies with negative earnings have in recent months outperformed stock prices of companies with positive earnings,” he noted on his blog.
Most of those unprofitable companies are tech companies, he told Coins2Day.
This quirk was also noticed by Morgan Stanley chief investment officer Lisa Shalett. “More than a third of the Russell 2000 remains unprofitable [and] small-cap companies’ cost of capital is well above their return on assets,” she said in her most recent weekly note.
Savita Subramanian and her team at Bank of America share these worries. In a recent memo, they indicated that stocks were “frothy to bubbly”, as the S&P 500 now surpasses its level from the 2000 dotcom bubble year across nine out of twenty indicators they employ to assess if equities are entering bubble territory, according to “richer”.
“Of 20 valuation metrics we regularly track, the S&P 500’s market cap to GDP, price to book, price to operating cash flow, and enterprise value to sales have hit new records,” they said. “The index eclipses its March 2000 metrics on five others: Price to GAAP EPS, median P/E, EV/Ebitda, S&P v. WTI, and S&P v. Russell 2000.”
However, context is important, they said: “Historical comparisons are problematic, as today’s S&P is higher quality, asset light, less levered, etc. But risks are mounting, and the valuation floor for the S&P 500 is likely lower than today’s levels.”
So are tech stocks going to crash?
Should the U.S. Federal Reserve proceed with its anticipated interest rate reductions, making new funds more affordable, this could stimulate increased investment in technology. This is especially probable given the ongoing intense activity in AI sector acquisitions. (It's prudent to scrutinize the caliber of these transactions; as highlighted by the Wall Street Journal in today's reporting, AI revenue does not exceed AI capex.)
“Our U.S. GDP growth forecast of 2.3% for 2026 significantly exceeds the consensus estimate of 1.7%. However, we assume digital tech investment as a share of GDP won’t increase further. If digital tech investment does increase, then U.S. GDP growth could be almost double the consensus expectation and far surpass growth rates of other advanced economies,” Ben May of Oxford Economics said in a research note. He believes that if tech capex continues to grow, U.S. GDP could hit 3% next year.
That doesn’t mean that the stock market is partying like it’s 1999, he wrote. “Due to significant structural shifts over the past three and a half decades, the recent increase in tech investment began from a much higher point than in the early 1990s. As a result, there’s no clear reason why surpassing the late 1990s peak in the ratio should indicate that AI investment is in a bubble. Even if it were, the bubble could continue to inflate.”
Here’s a snapshot of the markets ahead of the opening bell in New York this morning:
- S&P 500 futures were down marginally this morning. The index closed up 1.07% in its last session.
- The STOXX Europe 600 was flat in early trading.
- The U.K.’s FTSE 100 was up 0.22% in early trading.
- Japan’s Nikkei 225 was up 0.27%.
- China’s CSI 300 was up 1.53%.
- The South Korea KOSPI was up 0.24%.
- India’s Nifty 50 was up 0.098% before the end of the session.
- Bitcoin was down to $108K.