The Tech Sector Is Now The "Most Overweight It's Ever Been"

At the end of May, we highlighted that after an unprecedented buying spree, which has sent the Nasdaq to nosebleed record levels, a crack had appeared in the second tech bubble: after weeks of relentless inflows into the sector, tech had suffered its largest outflow in over a year.

Was this the sell signal many had been looking for, sellside analysts wondered: Miller Tabak's Matt Maley said in a note to clients that"everybody remembers 2000, so they might be getting a little nervous with this development. I just wonder how many people have said to themselves, ‘If AMZN gets to $1,000, I’m going to take at least some profits."

One week later the answer is: virtualy nobody.

Which is a problem, because while nobody wants to be the first to sell this momentum juggernaut sector, where a handful of tech stocks are now responsible for more than half the S&P YTD returns, the warnings are getting louder and louder.

As Bank of America observes, in May, tech - the month's best-performing sector - saw its P/E expand most. At 19x, it trades at its highest levels post-crisis, but more concerning is that tech is now the most overweight it has ever been, including the tech bubble, by large cap active funds in the history of our data - particularly the FANG stocks.

Ok, so everyone is "all in", but is it overvalued? The answer depends on what valuation multiple one looks at. Although Tech's 8% premium to the S&P 500 P/E is the biggest premium since 2010, perhaps surprisingly it remains low relative to history, even excluding the Tech Bubble. Within Tech, all industries are trading either below or in-line with historical average relative P/E multiples, and notably, valuations within Communications Equipment, Internet Software, Semis, and Tech Hardware suggest 15-50% implied upside if multiples were to mean-revert.

There is a big "but" - P/E multiples are based on adjusted, non-GAAP earnings, which in addition to many other items, also exclude stock-based compensation.

Which is why in addition to P/E, BofA also looked at tech on an EV/Sales basis, where it finds that "tech looks stretched." This is what it found:

Based on EV/Sales, which would not be impacted by accounting differences such as the inconsistent treatment of stock-based compensation - a large expense for many Tech companies that we estimate could understate Tech's current P/E by as much as 10%, Tech trades at its highest relative multiple since the Tech Bubble, and is trading well above average even when excluding the Tech Bubble (Chart 1).

And while EV/Sales may be the highest since 2000, and 50% above average, momentum chasers active managers will respond that it is not at the all time highs just yet: with the ratio at 1.8x currently, it still has over 40% before catching up to the bubble highs of 2.6x...

...which would mean AMZN can easily hit $1,400 before it rolls over, a price which would mean Jeff Bezos' net worth would be roughly $120 billion.