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Tech Rout Continues; History Says It Signs Point to A Bubble Burst

About 40% of Nasdaq stocks, the techiest of the Big Three U.S. indexes, have lost half their value since November, ringing a burst alarm bell.
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For someone who has been watching the stock market screens recently, the color red seems to dominate. 

And by far. 

After gaining 22% last year, the Nasdaq stock index is down almost 18% from its November high. 

It has entered a correction territory, which means it has dropped more than 10% from its recent highs. The sell-off continued on Monday, as the index was down almost 4% at the time of writing.

More than half of the Nasdaq's 3,000+ stocks are tech. 

The fall of the Nasdaq, which comes after several months marked by records, makes some say that we are in a tech bubble which is about to burst, while others believe that it is just an inflatable balloon which is deflating.

"Today in the U.S. we are in the fourth 'superbubble' of the last hundred years," Jeremy Grantham, co-founder and chief investment strategist of Grantham, Mayo, & van Otterloo, said in a report.

Adding, "In a bubble, no one wants to hear the bear case. It is the worst kind of party-pooping. For bubbles, especially 'superbubbles' where we are now, are often the most exhilarating financial experiences of a lifetime."

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But for M.F. Siegler, "it’s not and never was a bubble. Instead, perhaps it’s best to think of it more like a balloon."

"The air, which had inflated earnings multiples to the Moon in tech, is slowly but surely coming out, returning the balloon closer to Earth," he wrote.

To support his point he points out that, instead of dizzying daily declines of 10%, 20%, 30% crashes in value in a single day, we’re getting 1%, 2%, 3% dissipating from many stocks nearly every day. 

"The end result is similar, drops upwards of 50% in terms of price and market cap. But again, it has happened over weeks and months, not days," he concludes.

Why Are Investors Selling Tech Stocks ?

Recent sell-offs in tech stocks are mostly tied to inflation, which is at a 40-year high. To prevent a dizzying rise in prices from doing damage to the economy, the Federal Reserve has hinted that it would start raising interest rates this year, and analysts expect the institution to do it at least three times this year, starting in March.

This scenario makes less risky assets, such as Treasury bonds, savings accounts - just as attractive as tech stocks, whose economic model is future growth.

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The prospect of better and higher returns on investment from assets judged to be low-risk makes investors less inclined to buy technology stocks that sell promises.

The value of many technology stocks is based on their growth potential. 

Tesla  (TSLA) - Get Tesla Inc Report, for example, has a market capitalization 12 times that of General Motors  (GM) - Get General Motors Company Report despite the fact that GM sells millions of cars a year and Tesla barely sells a million.

Tech stocks had a meteoric rise because the Fed cut rates to near zero during the Covid-19 pandemic. The policy made tech stocks more attractive because potential growth is better than zero in interest rates. Now with the possibility of rates going up, investors are rebalancing their portfolios.

A sign on the new dynamic could be seen in government-bond rising prices on Monday, ahead of an important two-day meeting of the Fed, pushing down yields. Yields on benchmark 10-year Treasury notes slipped to 1.726% from 1.747% Friday. The 10-year Treasury climbed more than 20 basis points last week to start the 2022, marking the biggest advance to a new year since 2009.

Yields on interest-rate-sensitive two-year notes were down to 0.991% from 0.993% Friday.

Another warning sign is the large numbers of new and inexperienced investors - who entered the financial markets in 2020 and were a key force behind 2021's stock-market rally- are starting to get cold feet.

Retail investors have been buying shares of financials and energy companies, while their purchases of high-flying stocks like Advanced Micro Devices  (AMD) - Get Advanced Micro Devices, Inc. Report and Nvidia  (NVDA) - Get NVIDIA Corporation Report have been dwindling, according to The Wall Street Journal.

Are Tech Companies Overvalued ?

The Nasdaq 100, a stock market index made up of 101 equity securities issued by 100 of the largest non-financial companies listed on the Nasdaq stock market, has been down more than 1% in every session over the past week. This is a first since September 2001. The index had not recorded such a sad record in more than 20 years.

The Nasdaq 100 is on course for its worst month since the 2008 global financial crisis. 

On Monday, the pessimism seemed to persist: The Nasdaq 100 was down more than 3%.

The index tumbled 7.51% last week as what started as an aggressive selloff in speculative corners spread to the rest of the market. Disappointing results from pandemic darlings like Netflix Inc.  (NFLX) - Get Netflix, Inc. Report accentuated investor angst that as the economy recovers, tech’s growth edge is disappearing. 

Investors are increasingly questioning the valuations of tech stocks. 

Things could get worse: Net allocation to the technology sector fell to the lowest level since 2008, according to  Bank of America Corp.’s latest survey of global fund managers reported by Fortune.

Another way to see that investors believe tech stocks may be overvalued is to look at the price-to-earnings ratio, which links a company’s share price to its earnings. This metric is considered a valuation metric that confirms whether the earnings of a company justifies the stock price

The S&P 500 currently has a P/E of 24.59, down 2% from Friday, which means that the dollar amount an investor can expect to invest in a company member of the index in order to receive $1 dollar of that company's earnings has decreased.

Tesla’s P/E is currently over 281, while General Motors has a forward P/E ratio of 6.684.

The Volatility Index (VIX), which is the market’s preferred ‘fear gauge’, rose above 32 on Monday, values greater than 30 are generally linked to large volatility resulting from increased uncertainty, risk, and investors’ fear. 

In the late 1990s, investors piled into any company associated with the internet, pushing the valuations of the likes of Amazon  (AMZN) - Get, Inc. Report and IBM  (IBM) - Get International Business Machines Corporation Report to dizzying heights. Companies like WebVan and were valued at hundreds of millions of dollars despite making heavy losses.

But the rally came to an end in early 2000, when the Federal Reserve began raising interest rates to combat inflation, sparking an aggressive sell-off in some of those stocks that had traded at record highs. The index lost over 30% in two months, and many of these companies went bankrupt.

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