The stock market boom is led by the American “Glorious Seven”. But will it last? Was the recent crash just a temporary sign of uncertainty, or can we expect a correction like the one in early 2000 when the dotcom bubble burst?
The Nasdaq index in New York has been one of the winners of the year so far – because investors still have a lot of faith in the tech companies listed there.
Last week’s stock market quake has subsided. The Swiss stock index SMI closed on Thursday almost 9 percent above its value at the beginning of the year; the broad American stock index S&P 500 was even almost 17 percent higher. This is still a little less than the almost 20 percent at the peak in mid-July, but already 7 percent more than in the correction on August 5. This has proven to be a buying opportunity, because the majority of investors have decided to “keep it as it is” and not to expect a major stock market crash.
The technology-heavy Nasdaq Composite Index and the Japanese Nikkei have corrected the most. However, these had previously gained significantly in value.
The fundamental picture and the associated risks remain unchanged. Since the great financial crisis of 2007/08, we have seen an extremely strong technology-heavy stock market boom, which was only briefly interrupted by the pandemic.
Anyone who invested in the Nasdaq Composite Index of the 3000 most important technology companies at the beginning of 2009 has seen their money more than elevenfold in the past 15 years. With the S&P 500 it would have quadrupled; with the Swiss SMI it would have “only” more than doubled. All of these increases in value are significantly higher than the increase in economic output, i.e. gross domestic product (GDP), in the same period.
Stock prices embody expectations of future returns to which the buyer of a share is entitled. But is the euphoric optimism reflected in the share price trend of the past few years justified?
Everything depends on the “Magnificent Seven”
Our analysis shows that the high expectations are not only related to the general economic outlook, but that the price gains are driven decisively by the assessment of the large American tech companies.
In addition to the five American tech giants Apple, Facebook/Meta, Google/Alphabet, Microsoft and Amazon, the “Magnificent Seven” also includes the electric car manufacturer Tesla and the semiconductor chip designer Nvidia. Their market capitalization has increased from 370 billion dollars to over 15,000 billion dollars since the beginning of 2019. The seven companies are therefore worth more than half of the economic output of the USA in 2023 and 16 times that of Switzerland.
And that’s not all: the share of the “Magnificent Seven” in the total market capitalization of the 500 largest American companies has risen from 5 to 32 percent in the past 15 years; they now account for a third of all traded stocks.
Parallels to the dotcom bubble
This concentration inevitably brings back unpleasant memories of the Internet boom at the end of the 1990s. At that time, exaggerated hopes for the future suddenly drove the value of companies operating on and with the Internet, such as eBay, Cisco, Qualcomm, Netscape, Yahoo and AOL, to dizzying heights. The correction came between spring 2000 and summer 2002 and was painful. Cisco lost 86 percent of its value, Qualcomm 80 percent and even Amazon 74 percent. Netscape, Yahoo and AOL have long since disappeared from the scene as independent companies.
However, eBay is now worth 23 percent more than it was at the height of the dotcom bubble in spring 2000, Cisco 34 percent and Qualcomm as much as 77 percent. But shareholders had to endure a long dry spell. This was most worthwhile for the former Internet book retailer Amazon, whose value has increased 77-fold since the dotcom boom in spring 2000.
The question is whether the glorious American tech companies mentioned above should be in danger of suffering something similar to what happened when the dotcom bubble burst. And whether the same thing will happen to them as happened to eBay or even Yahoo, or whether they will suffer the same fate as Amazon.
If you look at the stock market in general, or the ratio of the market value of shares to the average earnings of the past ten years, this so-called Shiller price-earnings ratio currently shows similar proportions to those before the dotcom bubble burst. This Shiller price-earnings ratio (P/E) is currently back at 38; at the turn of the millennium it was 42 – much more than its long-term average of 21. In this sense, shares are very expensive and a crash of more than a third would be quite likely.
Profitable and powerful
However, this is too backward-looking a view. The four big American IT giants Apple, Google, Meta and Microsoft are currently enormously profitable, powerful companies with growing revenues. In the second quarter of this year alone, according to Bloomberg, they earned earnings before taxes and depreciation (EBITDA) totaling 112 billion dollars. Their EBITDA margins were between 34 and 55 percent.
According to Bloomberg, the current P/E ratios of the American IT giants are all around 25. The Internet retailer Amazon, which is making large investments, Tesla, which is struggling with difficulties and growing competition, and Nvidia, which is driven by cyclical AI hopes, are the outliers with P/E ratios between 50 (Amazon) and 175 (Nvidia).
The central importance that American tech companies have achieved is illustrated by their sharp increase in research and development spending. Over the past ten years, this has increased from a good 10 billion dollars in the second quarter of 2015 to 66 billion in the second quarter of 2024. This means that the “magnificent seven” alone accounted for around 6 percent of all research and development spending made by private individuals and the state in the USA according to the national accounts.
However, as economist Philippe Aghion and his team have shown, this strength and power also give rise to their problems and vulnerability. Firstly, they are obviously using part of it to prevent potential competitors from entering the market. In this way, they have recently slowed down the USA’s innovative power, after initially increasing it sharply as “superstar companies”. Secondly, the sharp increase in research spending is a sign of the uncertainty brought about by the boom in artificial intelligence (AI) and the hopes of a productivity boost thanks to generative AI such as Chat-GPT.
All of the major American tech companies are currently racing to secure their previously dominant market position. As an analysis by “The Market” this week shows, analysts expect capital investments by the four major American IT companies alone (excluding Amazon) to amount to 206 billion dollars this year and 228 billion dollars next year. That is more than twice as much as the five energy companies Exxon Mobil, Shell, Total, Chevron and BP plan to invest this year and is linked, among other things, to the expansion of cloud infrastructure.
However, it remains unclear whether this will actually secure the future market dominance of the current American tech giants. The electric car manufacturer Tesla is already under strong competition from traditional car manufacturers and new, more dynamic Chinese suppliers. How long Nvidia will be able to maintain its lucrative partial monopoly position in microchip design is also uncertain.
It is foreseeable that the large American tech companies will come under pressure on several fronts in the near future:
- Anti-monopoly proceedings: First in Europe, but now also in the USA, the competition authorities have launched various proceedings in which they accuse the operators of the large digital platforms of exploiting their dominant market position in a way that is damaging to the economy. They face heavy fines and possibly even a forced break-up.
- Unclear future of AI: The rapid emergence of generative artificial intelligence is putting pressure on the tech giants and requiring them to make huge investments. It remains unclear whether and how these can be converted into additional revenue streams in the future. In addition, technologically superior new providers could dry up the revenue sources of the market leaders.
- Increasing capital intensity: Until now, the Internet giants and the leading microchip designer have generated high revenues with a comparatively low investment of capital. The large investments in cloud and data infrastructure that are now apparently necessary could change that and lead to a dilution of returns on capital.
- Deglobalization: The American tech giants are leading beneficiaries of globalization. In some cases, their services have a dominant presence in large parts of the world, even without a physical presence. The system competition between the USA and China and the associated at least partial division of the world into geopolitical blocs is increasingly segmenting the markets and thus also the profit opportunities of American tech companies. This is all the more true as concerns are growing about the risks of political influence associated with the use of their products or even opening the door to hybrid warfare.
A majority of investors still seem to believe in the high expectations of future earnings of the “magnificent seven” reflected in current prices. Their dominant position, profitability, innovative power and the network and scale effects from which they benefit provide arguments for this. But as the dotcom bubble has shown, the risks associated with such price increases are considerable and a more differentiated view is worthwhile. It is uncertain which of the seven will suffer the same fate as Netscape and which will emerge as the new “Amazon” – it is possible that the up-and-comer of tomorrow does not even belong to the glorious club yet.
But this perspective also offers a reassuring outlook for investors: Anatole Kaletsky of Gavekal Research recently pointed out that those who avoided the dominant dotcom companies during the Internet boom did not fare badly. In fact, a comparison of the development of the S&P 500, which is dominated by these companies and is weighted by size, with the SPW index, which weights all companies equally, shows that the equally weighted index lost significantly less value and quickly began to rise again.
If the analogy is correct and we are actually witnessing the formation of a tech and AI bubble, then those who have invested in tech companies and the Nasdaq are currently profiting. For the future, however, they would be better off avoiding the highest-valued “magnificent seven” or the superstar companies in general.