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Client Update - 15th March 2024

Recently, I have noted that a number of my conversations with clients have gravitated towards a pressing question: Are we in another tech bubble?

Two years ago, the financial world braced itself as the era of exceptionally low interest rates was ending, affecting the stability of nearly all asset classes. The era of near-zero interest rates, post the great financial crisis, faced criticism for its role in fuelling a financial bubble in certain asset classes. As inflation took hold and interest rates rose, share prices and government bonds alike experienced declines, leaving investors with few places to hide. This is why the Financial Times described 2022 as the worst year for private investors in 40 years.

However, less than 18 months after the US stock market reached its lowest point, global markets are well on the way to recovery, and this is largely attributed to the stellar performance of US tech stocks. Markets never cease to surprise. Calm, patience, discipline and a long-term perspective have never ceased to disappoint in all my years as an investor.

That said, many investment professionals view the current market conditions in tech stocks as a parallel with the dotcom bubble of the late 1990s, rather than a conventional bull market.

To answer this question we look at Cisco, which, like Nvidia today, was integral in supplying the hardware necessary for the tech boom of the late 1990s. Any investors who purchased shares at their peak in March 2000 and have held to today would have experienced a real-term loss of nearly 66%. In hindsight (and to some in foresight) Cisco shares were a classic bubble.

This brings us to the first major test of a bubble: a widespread adoption of an attractive investment narrative. Almost every bubble starts with a good idea that makes sense. In the 1990s, the rapid development of technology and the emergence of the internet promised a disruptive change to all aspects of business and life. Investors were right that the internet would be revolutionary, and that the networks switches Cisco made would power this. The problem was that too many speculators became too optimistic too quickly. All bubbles reach their peak with the widespread belief that “this time is different”. This same sentiment is mirrored in the current enthusiasm for artificial intelligence stocks today.

Cisco illustrated the second classic test of a bubble: buyers push asset prices far beyond what economic fundamentals can justify. The question of an asset's "true worth" becomes irrelevant and the only concern is whether it can be sold for a higher price later. Speculative fever is the only thing that matters. Today it looks as if large tech stocks are expensive, trading around 35 times their expected earnings. When compared to the peak of the dotcom bubble, where industry leaders' prices averaged 63 times their earnings, today's valuations appear more reasonable. The second test of a bubble in today's AI stocks probably falls short, for the moment.

The final test of a bubble is the most important: that prices will inevitably collapse. The nature of a true financial bubble is that it has grown so large it will burst under its own unsustainable weight. Once the last pool of buyers dries up there is nothing to support the inflated prices. Predicting the magnitude of the crash is as speculative as trying to pinpoint the bubble's peak, underscoring the precarious nature of investing in such conditions. The financial health of today's tech giants presents a stark contrast to the speculative favourites of the late 1990s, like Cisco. Back then, start-ups with untested business models quickly reached multibillion-dollar valuations. Nowadays, the leading tech companies are deeply integrated into the global economy. This fundamental distinction between the two periods also extends to the context of market trading. The current rise in prices, to some extent, can be seen as a corrective rebound following the significant downturn experienced by mega-cap tech stocks in 2022. So, it is far from clear if AI stocks today are a true bubble or are merely trading at very expensive valuations.

Despite this, the absence of a sure-fire bubble does not necessarily imply that these stocks will continue to rise. Reflecting this perspective and recognising the broad opportunities present in other global equity sectors, our investment team has recently decreased their exposure to technology stocks. Instead, they are shifting focus towards sectors they view as less crowded and offering more attractive valuations and income opportunities. As the landscape evolves, keeping an eye on fundamental values and diversifying investments will remain key to adapting and thriving in the ever-changing financial markets. When the outlook for an investment is so uncertain, bubble or not, common sense should prevail. Do have a good weekend.

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