Back to top

Tech Bubble 2.0 + Inflation Tsunami: How to Play Them Now

Read MoreHide Full Article

This week, Morgan Stanley Wealth Management's CIO, Lisa Shalett, warned clients about the increasing probability of a big stock market correction. She put a price tag on that swoon of up to 15% and pinned the blame on "bubbly like it's 1999" technology stock valuations (my air quotes, not hers).

In the video that accompanies this article, I show her primary data view in one chart that says 10,000 words. It's the price-to-sales ratio for the S&P Information Technology index since 1990 just about to eclipse the 7.5X reading we saw in the dot-com bubble of 1999-2000.

While many of us technology investing fanatics have been saying that the current bull run is nothing like the dot-com mania -- because this one has massive earnings and disruptive innovation behind it -- I have to admit we are starting to get a bit long in the tooth now.

And on the same chart, Shalett and her team show the P/S ratio for the broader S&P 500 index now exceeding 3X -- when the dot-com bubble high was under 2.5X.

This is mostly a function of the fact that Info-Tech is now such a big proportion of the cap-weighted index at over 25%, with the trillion-dollar valuations in Apple, Microsoft, Amazon, Alphabet, and now Facebook.

Where I may disagree with Shalett is in her assessment that low interest rates have been the central culprit to prop up tech stocks to dot-com era valuations. What about massive sales growth from disruptive innovation in consumer, enterprise and industrial markets that have capitalized on software, mobile, cloud, and automation/AI technologies?

Well, let's hear from the strategist herself to understand the nuance involved...

"The problem with this setup is that tech sector profitability and earnings are vulnerable. While secular growth trends may support resilience against small changes in economic growth, the sector now faces unprecedented headwinds from rising input costs, a weaker US dollar, fiercer competition, higher taxes, stricter regulations and customer backlash."

There's a lot to unpack out of the Amazon container of headwinds she just delivered. But the nuance that bears mentioning is "earnings are vulnerable."

This is always the case. We've had a huge resurgence in earnings growth the past year and stocks -- driven by quant investor appetites -- have rightly pushed indexes to new highs.

So if she's right that the growth is about to level out, then stocks could be in for a sell-the-peak moment.

Who's Afraid of the Inflation Tsunami?

The loud part that she kept quiet was the inflation threat. We've been in a tug-of-war all year between investors who believe that old, mythical monster (those younger than 40 have never seen it) is about to destroy the economy and those who think it's transitory.

In the video, I share the insights of the world's biggest asset manager, Larry Fink from BlackRock. In a Reuters interview reported by Saqib Iqbal Ahmed, BlackRock's CEO said he does not see inflation as transitory and that the U.S. Federal Reserve will have to react to higher inflation numbers.

"I am not calling for 1970's inflation but I just think we are going to have above 2% inflation .. probably closer to 3.5% to 4.0%. Does that mean the Federal Reserve will have to change policy? I think so."

My take: The Fed is fully prepared to let inflation run hot -- say 2.5% to 3.0% -- and get back to full employment. They don't see the world the same way as Volcker or Greenspan did because they recognized the massive deflationary forces of technology innovation, global labor competition, and overall employment disruption.

So if the Fink is right, the Fed may indeed have to move 50 or 100 basis points higher in the short rate just to trim excess speculation in the economy and tamp down wage inflation -- which we've been waiting for forever!

When I asked Zacks Chief Economist John Blank what he thought, here was his reply...

Larry Fink is part of an emerging group of thinkers/investors who are joining Biden administration initiatives to the inflation outlook. So far, the rise is built out of a medley of unusual reopening/past regime forces like new and used and rental car price hikes.

Mr. Fink thinks a new wage-price hike policy combo enters and follows this. The overall price increase may be higher, but the underlying circumstances are vastly different. I think there is plenty of time to see the evidence of this, before joining that new group.

The Tech Super Cycle

Which brings me to my next big topic in the video: technology innovation kills inflation.

In 2017 I wrote one of the most important investment articles of my career: The Technology Super Cycle. That link will take you to a 2018 vlog where I reveal the primary thesis.

In today's video, I also cover a lot of the important points about two big mysteries that explain why the market went from S&P 2000 to 4000 and beyond.

Those "mysteries" are all about (1) why does the government report such lame productivity numbers when we see it ramping in industries all around us from the smartphone in our hands to the automation in our cars, homes, and offices; and (2) why does inflation appear to be an extinct species even as stocks go through the roof and gold as an inflation hedge remains an also-ran?

In the video I address both questions and their answers that I nailed down in 2017, with the help of two visionary economists -- and Jensen Huang of NVIDIA (NVDA - Free Report) .

Moore's Law to Become Huang's Law?

Some investors are Tesla disciples and others love Apple. I don't judge either of them.

For me, my fascination (and money) are with Jensen and NVDA. In my original 2017 thesis on The Tech Super Cycle, I used a graphic that explained how NVIDIA was essentially recreating Moore's Law with the "massively parallel architectures" of GPU stacks. This vlog from March 2017 gives a good intro...

Get Your "MPA" in Deep Learning

You'll have to see the images I share in today's video to understand the exponential math, but basically I am renaming Moore's Law to Huang's Law since he is the master architect now of the next several generations of IT computing power and AI/ML/DL. I covered a lot of this in these two recent pieces...

AI Dreams and Reality: Investing in Advanced Technology

In this article and video I explain how Artificial intelligence is expected to create $50 trillion in economic value this decade as it transforms the world. I also take a peek at the new supercomputer that Jensen & Co. just helped Elon & Co. build for Tesla (TSLA - Free Report) .

NVIDIA and AMD: Digital Flywheels of Super-Exponential Innovation

In the above link from June 30, I go over how AI is accelerating at exascale with the marriage of GPU super-computers and advanced simulation software. And since NVIDIA is not alone here, I highlight the other key player I own, Advanced Micro Devices (AMD - Free Report) .

Cathie Wood on Cyclical Deflation

As a welcome adjunct to my constant babbling in this presentation, I share a quick clip from ARK Invest's Cathie Wood on the persistent deflationary forces that she sees across industries and equity markets that are in fact driving as much "destruction" as disruption in her words.

Since I have been writing about this debate even before we met the queen of disruptive investing, I am very interested in her research, beliefs and theories.

She calls the big trend "cyclical deflation" which sounds somewhat transitory. I'll have to look at more of her work, but I bet she wouldn't argue with it being called "structural" or "secular" deflation since it's a megatrend that seems to live outside the vagaries of economic cycles in the past five decades.

In fact, when I've heard Wood talk about technology innovation and deflation, her big example is the late 19th century when railroads, electricity, and the telegraph were changing history. Part of her theory is based on Wright's Law about about cost declines. From the ARK Invest page where they describe this little discussed "learning curve"...

Pioneered by Theodore Wright in 1936, Wright’s Law aims to provide a reliable framework for forecasting cost declines as a function of cumulative production. Specifically, it states that for every cumulative doubling of units produced, costs will fall by a constant percentage.

I close today's video with a look at some of ARK Invest's research in one of my favorite "disruptive innovation" areas: Biotechnology. I just jumped back into Invitae (NVTA - Free Report) shares this week and coincidentally their genomics analyst just published an industry breakdown showing how the company is leading in the unique nexus of genetic testing, bioinformatics, and molecular diagnostics using AI.

Many Biotech investors were just taken on a wild ride in the first half when funds like the ARK Genomic Revolution ETF (ARKG - Free Report) soared and then stumbled. But this area is one where vigilant stock-picking and patience pay off. We just banked another double on Intellia Therapeutics shares in Q2 after their impressive in vivo CRISPR data and I expect to do that again soon with Editas Medicine.

Finally, if you want a good and brief overview of NVIDIA's business and why I always buy the dips on the way to $1,000 here's my July 4th article on the titan of AI...

Bull of the Day: As king of AI creates exascale supercomputers for Tesla, path to $50 billion in revenues opens

Remember, when the correction comes, buy it with both hands. And don't say I didn't warn you.

Published in