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Is This Another “Dot Com” Bubble?

  • There is talk of a bubble in the technology sector again, with references to the 1995 to early 2000 period when the NASDAQ composite index rose 570%. Currently, the ten most valuable stocks in the S&P 500 and the Russell 1000 benchmarks now account for 30% and 26% respectively of these market indices and the five largest have reached a record high share for modern times. However, Citi analysts believe this is not a “Dot Com” repeat. There appears to be no technology sector recession in sight as there was in 2000.
  • Unlike the late 1990s, when hundreds of technology “concept” firms with little immediate profit rose to more than 15% of US market capitalization, today’s technology firms are large, highly profitable conglomerates.
  • Furthermore, the COVID-19 economy – with its requirement for remote life and work and with social distance – also requires digitization. As an example, e-commerce retail sales have jumped to 18% of total US retail merchandise sales.

 

But selectivity is key

  • However a fundamentally strong sector may end up a victim of its own success. Free cash flow (FCF) and profitability are likely to matter more and more as the pandemic grows and finally ends. What we have seen in 2020 is a “lift-off” where market caps are trending upwards faster than profitability.
  • Citi analysts also see that a sizable number of software firms are not generating FCF and only a few are doing so at sustainably high levels. Investors must, therefore, assess the sustainability of growth for many firms amid rising concerns that rising FCF and profitability may be elusive relative to rising expectations.
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What does this mean for portfolios?

  • For clients with portfolios that may be excessively overweight to technology, there are several strategies to consider: (1) Consider reducing some of these positions and rebalancing into other overweights in cyclical sectors, including industrials, small- and medium-cap sectors and certain non-US markets such as Asia. (2) Health care sector is also another area to consider as it may have a much higher potential of sustained profitability given demographics, though these have also performed well in 2020.
  • To reiterate, “Digitization” is still one of Citi’s long-term Unstoppable Trends and could offer strongest growth opportunities in portfolios. While Citi analysts suggest that clients maintain positions, they prefer to avoid over-concentration in portfolios.

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