Tech Stocks Exceed Dotcom Era Valuations as UBS Warns of Correction Risk

Technology stocks have surpassed the excess returns witnessed during the dotcom bubble, prompting analysts to question whether recent market volatility represents a buying opportunity or the onset of an extended correction period.

UBS has cautioned that the artificial intelligence driven technology rally has propelled excess returns for US momentum and technology stocks beyond the levels reached at the peak of the dotcom bubble in March 2000. The bank suggests that increasingly hawkish central banks could trigger a repeat of the severe 1999 to 2000 correction.

The analysis, produced by Michel Lerner, head of HOLT at UBS, refrains from declaring a definitive market top but frames the central question facing investors: does the recent technology sector sell-off constitute another dip worth buying, or does it mark the beginning of a genuine valuation derating towards historical norms?

The bank’s HOLT valuation framework identifies a crucial distinction from the dotcom era. Today’s technology sector generates substantial real cash flows, with US technology sector economic profit standing at approximately ten times its 2000 level. When assessed using conventional earnings-based multiples, valuations therefore appear less extreme than during the internet bubble.

UBS contends that an alternative measure reveals a more concerning picture. The bank’s HOLT percentage Growth metric, which quantifies the proportion of a stock’s value dependent on future reinvestment rather than existing cash flows, indicates that the artificial intelligence value chain is now priced to generate supernormal profits at historically unprecedented levels.

This pricing implies that investors expect a disproportionate share of artificial intelligence related value creation to accrue to the technology enablers, such as chipmakers and infrastructure providers, rather than to the broader economy of companies adopting the technology. UBS argues this assumption contradicts expectations that artificial intelligence will diffuse widely to drive productivity gains across multiple sectors.

Market leadership has narrowed to a historically unusual degree. In the United States, only one in three stocks across the market has outperformed the index over the past three months, representing the lowest proportion since 1989. Artificial intelligence related positions rank among the most crowded long trades in UBS Quant Research’s crowding data.

The interest rate environment introduces a further dimension of risk. Given that a substantial portion of technology sector intrinsic value is tied to future growth, the sector behaves increasingly like a high duration bond, rendering it acutely sensitive to changes in discount rates. UBS Evidence Lab data indicates more hawkish central bank sentiment, and the bank warns that a renewed rise in inflation could replicate the 1999 to 2000 scenario in which the Federal Reserve raised rates aggressively into the bubble peak, triggering the subsequent crash.

Stretched valuations extend beyond technology. US cyclicals, including indirect artificial intelligence plays, and aerospace and defence stocks on both sides of the Atlantic also appear demanding according to UBS’s growth measures.

Conversely, UBS identifies energy stocks and European value names as areas where valuation and momentum scores appear attractive whilst crowding remains low. Shell, TotalEnergies, BP and Equinor all feature in the bank’s screen of stocks with strong fundamentals and undemanding implied growth expectations.