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Tech stock investors might have nothing to worry about

Myles Udland
Markets Reporter

Investors have long memories.

In 2000, after a bubble that saw the Nasdaq (^IXIC) gain nearly 500% in seven years, tech stocks crashed.

The Nasdaq lost almost 80% from peak-to-trough and in recent years, the market rally and particularly the run-up we’ve seen in tech stocks has had many asking if we’re in for a repeat of that painful crash.

On Wednesday, the S&P 500 (^GSPC) information technology sector, made a new record high for the first time since March 2000. Year-to-date, the Nasdaq is up over 18%. In early afternoon trading on Thursday, the tech-heavy index was again leading the market and on track to log a tenth straight day of gains.

NYSE traders

The standout stocks have been the now ubiquitous FANG stocks — Facebook (FB), Amazon (AMZN), Netflix (NFLX), and Google-parent company Alphabet (GOOGL). Year to date, each of these stocks is up better than 25%, with Netflix and Facebook rising more than 40% in 2017 alone. (On Tuesday, Netflix gained 13% after an earnings beat, sending shares to a new record high.)

Analysts at Goldman Sachs earlier this year slightly re-framed the group as FAAMG, adding Apple (AAPL) and Microsoft (MSFT). Also feel free to add an N — shares of chipmaker Nvidia (NVDA) are up 56% this year and the stock’s gains since the start of 2016 now total 407%.

Together, the FAAMG stocks have a market cap of nearly $3 trillion. In a note earlier this year, UBS strategist Julian Emanuel pointed out that through early June these stocks had accounted for one third of the S&P 500’s year-to-date gains, not an unusual state of affairs.

Throughout the last two decades, just a few stocks have often been the source of 20% or more of the market’s total return. (Source: UBS)

But as research has shown, most of the market’s total return is always driven by just a few constituents. This is also why low-cost indexing is the best way for individual investors to bet on the stock market: the chances you pick a losing stock far exceed the chances you pick a winner.

So is it time to be worried about tech stocks?

As Yahoo Finance editor-in-chief Andy Serwer said Thursday, the only thing to be worried about is that tech stocks (as measured by the S&P 500 IT sector) are up 23% year and much more when looking at the aforementioned FAANNMG stocks. (FAANNMG doesn’t have quite the same ring to it, in fairness.) And anything that goes up that much in a short period is vulnerable to a price adjustment in the short run.

But unlike the pre-tech crash bubble, the tech sector as a whole has strong earnings growth.

In a report earlier this month, analysts at BlackRock (BLK) highlighted the following chart showing that tech earnings have risen in-line with the index’s price.

Tech earnings have risen in-line with the index’s price rising, unlike during the tech bubble. (Source: BlackRock)

“The technology sector has been a standout performer in 2017,” the firm wrote.

“The global tech index is again approaching the peak levels seen in the early-2000s dotcom bubble. The big difference today? Gains are being supported by corporate profits. The tech sector has the highest forecast earnings growth in 2017 outside energy and materials.”

Of course, like Serwer, many see the price rally in tech stocks and get nervous because anything moving that far that fast is vulnerable to a slowdown. And rightfully so.

Another reason for caution could be the way investors have become convinced that anything these companies even mention doing will crush their competition — see Blue Apron’s drop after an Amazon patent filing and Home Depot and Lowe’s dropping following news Amazon would try to sell appliances.

Home Depot, Lowe’s, and Blue Apron. Three companies getting “Amazon’d” this week alone. (Source: Yahoo Finance)

Still, earnings are strong and this rally, while perhaps a bit enthusiastic, is not built on nothing.

“The development and adoption of new technologies is changing the business model for nearly every industry, from retail to energy production,” BlackRock wrote.

“We believe we are still in the early stages of this transformation. The pie is not getting bigger in many sectors, but tech is stealing a larger slice. Many leading tech firms are found in other sectors (think online retailers). This means the sector’s influence goes beyond it 17% weight in the MSCI ACWI Index.

“Overall, tech valuations are not cheap, but we see stable and sustained earnings growth offering better support than in other sectors. We see tech as a long-term growth opportunity but brace for the risk of sudden reversals after sharp price gains.”

Myles Udland is a writer at Yahoo Finance. Follow him on Twitter @MylesUdland

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