Colin McLean: Is technology bubble at risk of bursting?

Certainly, a stock market making new highs, as the US has this month, often continues that trend for a while longer.

And Facebook owner, Meta, has also moved to a new high on excitement about artificial intelligence (AI), a jump in revenue and news of a first dividend for shareholders. But amidst the current global fascination with technology and AI, investors must note growing risks in the global economy.

Bubbles rarely give clear signals at the top, but often there are signs of stretched valuations. Japan in 1990, Dot Coms in 2000 and the finance sector in 2007/8 were all driven by appealing stories and a desire by many investors to jump aboard a trend. There were few doubters, but even they were confounded by just how long the trend ran and how high shares reached.

Today, there is nothing in the results or forecast profits of the technology sector that rings an alarm bell, and the outlook seems clearer than many other sectors. Investors in the sector argue that the leading global technology businesses have done much to cut costs and improve efficiency and profitability. But the valuation of one of the individual businesses expected to benefit from AI now exceeds that of the entire US listed energy sector.  That is despite total profits across the energy sector being several-fold higher.

Expectations of earnings acceleration in the major global technology businesses may depend on a lack of any geopolitical upset or slowdown in Europe and China.

However, the Chinese economy is slowing with persistent deflationary pressures, lagging other emerging economies. Its stock market has been slumping in contrast with the US. Optimists expect money to be pumped in by China’s central bank, but the weak trends may be driven by a bigger problem; China’s property bubble. Surplus homes and excessive borrowing in its real estate sector has already brought down two property companies and may force more widespread debt write downs. Restructuring in the sector looks to be a continuing constraint on the Chinese economy and a headwind for global growth.

Although less worrying than China, recent data points to signs of economic slowdown in the UK, Germany and the US. A German economy at a standstill will be a drag on European growth. Central banks appear too concerned about controlling inflation and wary of cutting interest rates quickly.

Much of the post-pandemic inflationary pressure in developed economies came from supply disruption and the money printing of the central banks themselves. But those banks continue to to overestimate their degree of control over consumers and businesses. Globally, debt remains high relative to the ability of businesses and economies to service interest costs on those borrowings. Lower or no economic growth is now adding to that challenge.

Trying to guess whether monetary stimulation might boost stock markets or when debt realities might impact growth is rarely a helpful approach to investing. Trends can continue much longer than expected and confound the sceptics. A more useful approach is to consider the balance of a portfolio and how it might react overall to possible economic scenarios. Key is whether any risks are disproportionate or would upset longer term financial planning by an investor.

Those risks might be in herding into any sector or individual stock market, where valuations are optimistic. Investors who switched some of their investment from London to New York have done well over the past 12 months.

The US stock market now represents 70% of the global total, with the UK less than 4%. But the challenge now is to consider valuations and longer term outlook to build resilience into a portfolio.

Colin McLean is a director of SVM Asset Management Holdings