Could Technology Stocks Falter?...

No doubt about it, technology stocks are king. For the year, they’re up 25.6% versus the overall S&P 500’s return of 11.7%. And for the decade, large technology stocks are up 350%. That’s not even mentioning the stunning returns of bellwethers like Netflix, up more than 2100% the past five years, or Facebook, up 650% over the same period.

Technology’s reign won’t last forever. It can’t -- simply because nothing lasts forever. The problem is that it’s awfully easy to forget this when things are going so well. As investments grow in popularity, people start turning a blind eye to the risks, and things get heated beyond reason. While this doesn’t mean in any way that technology will face a spectacular demise à la 2001-02, there is reason to stay alert and pay attention.

Morningstar called technology stocks “notably overvalued” and saw the sector trading at 1.13 time its fair value in July. And Ruchir Sharma of Morgan Stanley recently wrote in The New York Times that there are growing signs of irrational euphoria in tech. Seven of the world’s most valuable companies, he noted, are in the technology sector. What’s more, it’s always a disconcerting signal when investments get bundled and labelled into acronyms like FANG (Facebook, Amazon, Netflix and Google) or FAAMA (Facebook, Alphabet, Apple and Microsoft).

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Remember the BRICs, he asks? That was the name given to the emerging markets of Brazil, Russia, India, and China, which also were bundled together as the best party in town until it wasn’t. Now on top of FANG and FAAMA, we also have the holy trinity of BAT from China – or the internet stocks of Baidu, Alibaba and Tencent.

There are plenty out there who believe that technology stocks aren’t overvalued, and Sharma acknowledges that valuations aren’t nearly at the extremes seen during the internet bubble at the turn of the century. But, he says, the overvaluation is partially masked because so many technology companies are choosing to stay private rather than go public.

The number of private technology companies with high valuations has been raising eyebrows for some time. Worldwide, there are 260 “unicorns” or private companies valued at $1 billion or more. But how they get valued is something of a black box. A recent study from Stanford professor Ilya Strebulaev found huge discrepancies in the worth of unicorns – and an average overvaluation of 51%. The risk is that their valuations come into question and then cause a chain reaction that spills into public markets.

Sharma suggests that one thing to look out for is more regulatory scrutiny. The hue and cry over tech giants holding too much power has been growing, and the suggestion is that regulatory intervention might be needed to break up their monopoly-like power. According to a recent Bloomberg article, Google gets 77% of U.S. search advertising revenue, Google and Facebook together get 56% of the mobile ad market and Amazon controls 70% of e-book sales and 30% of all U.S. e-commerce. Some sources cite even higher numbers. In any case these aren’t numbers that would be ignored in other industries.

Author Jonathan Taplin, has written a whole book about the monopolization of the internet called Move Fast and Break Things: How Facebook, Google, and Amazon Cornered Culture and Undermined Democracy. And former Labor Secretary and public policy professor Robert Reich has opined that the tech giants must be broken up. That would mean a whole new way of doing business.

In the meantime, Sharma suggests that investors look for the traditional signs of concern when it comes to stock investing. One is rising interest rates – since he notes that nearly every bubble since the Nifty Fifty in the 1960s has ended with tightening monetary policy. The other is earnings falling short of analyst estimates – a sign of expectations getting ahead of themselves and a few too many investors falling in love with the same thing.