SocGen Warns of a ‘Bubble’ as Stocks Wrap Up Worst Week Since April

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US stocks plunged this week and the tech-heavy Nasdaq Composite lost 3.65% while the broad-based S&P 500 lost nearly 2%. However, the Russell 2000 ducked the bearish trend and rose 1.68% while the Dow Jones rose 0.72%.

Meanwhile, SocGen has raised the alarm over the valuations of tech stocks, drawing parallels with previous bubbles.

In a note earlier this week, Albert Edwards, SocGen’s chief global strategist warned that the boom in tech stocks could end soon.

SocGen Warns of a Bubble in Tech Stocks

“As time marches on, there are few of us left who were in the industry during the 2000 Nasdaq crash let alone the 1987 crash. I was there, and the one thing I have learnt is not to be complacent. Bad stuff happens and the warning signs are there if you look for them,” said Edwards.

The rally in tech stocks in particular Nvidia which became a $3 trillion market cap company helped catapult the Nasdaq as well as the S&P 500 to record highs this year. However, we saw a massive divergence, and many sectors were in the red.

Around 200 S&P 500 constituents were in the red in the first half of 2024 even as the index was up in double digits and rose to record highs. There has been a divergence in the fortunes of tech stocks and other sectors of the economy some of which are facing severe slowdown.

The market breadth was quite narrow and the steep rise in some tech stocks masked the pain in many other shares which were in the red.

s&p 500

Tech Stocks Account for Over a Third of the S&P 500

In its note, SocGen said, “With the US Tech sector now accounting for some 35% of the S&P 500 market cap, investors need to be on high alert for a potential bursting of the bubble.” Notably, that’s the highest ratio since the early 2000s when the dot com bubble burst.

The note said, “US Tech earnings have also risen strongly since the ChatGPT starting gun was fired. But those of us who lived through the 1990s will recall that the Nasdaq bubble back then was partly fuelled by physical investment in what turned out to be excess capacity.”

It added, “That Ponzi spending grew sector earnings, but never by enough to justify valuations. Some sceptics have already warned that the current AI excitement has similar characteristics.”

SocGen believes that tech companies might not be able to post the 30% earnings growth that markets are expecting and said that historically the growth has been around 20%. It pointed to the tech sector’s forward price-to-earnings multiple of 32x which is significantly higher than the S&P 500 and termed tech valuations as “stretched.”

SocGen Warns of a Tech Crash

It said, “And to what extent is this EPS growth enthusiasm similar to the overinvestment in cabling by the Telecoms industry in the late 1990s, fuelled by ‘free’ money? We could be about to find out.”

Edwards added, “What might pop this Tech bubble? A simple decline in EPS optimism might do the trick.”

Notably, a section of the market fears that the valuations of tech stocks are getting stretched and any correction in these names would drive US stocks lower in the back half of the year. That said, we have already started to see some rotation from tech stocks and large caps into small-cap and old economy shares as was well illustrated by the last week’s divergence between Nasdaq and Russell 2000.

Can Tech Stocks Rebound?

Meanwhile, not all buy SocGen’s pessimism toward tech stocks. Dave Donabedian, investment chief at CIBC Private Wealth is among those who believe that tech stocks can continue to rise in the second half of the year with other sectors also playing catch-up. According to Donabedian “You can have leadership from the technology space, but also have other sectors also going up.”

Donabedian, who is not too perturbed by the market valuations added, “So, I would say somewhere between now and the end of the year, the market will stumble and we’ll have a pullback or correction, because that’s normally what happens. But I think that the underlying fundamentals argue that by year end, we’ll be somewhat higher than we are now.”

Optimism Over Fed Rate Cut Rises

Multiple brokerages like Oppenheimer, UBS, and Goldman Sachs have raised their year-end target for the S&P 500 amid strong earnings growth and rising optimism over a Fed rate cut. Notably, the consensus view was quite circumspect from US stocks at the beginning of 2024 and the majority of analysts saw a flattish market this year.

Over the last month, Federal Reserve chair Jerome Powell has made some very dovish comments. Last week, speaking with David Rubenstein, chairman of the Economic Club of Washington, D.C., and co-founder of The Carlyle Group, Powell said that the Fed won’t wait for inflation to drop to 2% before it starts cutting rates.

The odds of a Fed rate cut by September rose to 100% and rising optimism over lower rates is also helping support the rally in US stocks. Meanwhile, it remains to be seen whether tech assumed its leadership or other sectors took over the baton in the second half of the year.

About Mohit PRO INVESTOR

Mohit Oberoi is a freelance finance writer based in India. He has completed his MBA in finance as a major. He has over 15 years of experience in financial markets. He has been writing extensively on global markets for the last eight years and has written over 7,500 articles. He covers metals, electric vehicles, asset managers, tech stocks, and other macroeconomic news. He also loves writing on personal finance and topics related to valuation.