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US stock market performance over the last three years has been strongly driven by technology and tech-like stocks, as we can see from the total return chart of the SPDR S&P 500 Index Fund (SPY) compared to the Sector SPDR funds. The tech sector has delivered nearly double the total return of the S&P over the last three years. The only other two sectors to beat the S&P are heavily weighted with tech-adjacent names.
Here is a quick recap of the Sector SPDRs since I will be using them in additional charts:
Aside from the Tech sector, we see only the Communications sector ahead of the S&P. That sector contains over 50% former Tech stocks including its top 4 holdings Meta Platforms (FB), both classes of Alphabet (GOOGL) (GOOG), and Netflix (NFLX). The Consumer Discretionary sector contains over 40% tech-like stocks including its top 2 holdings Tesla (TSLA) and Amazon (AMZN).
If this looks familiar, it is because a similar pattern was seen heading into the tech bubble top. The following charts start on 12/22/1998 because that was the IPO date of most of the Sector SPDRs. I am using the Fidelity Select Telecommunications Fund (FSTCX) as a proxy for the Telecom sector and the Nuveen Real Estate Securities Fund (FREAX) as a proxy for the Real Estate sector.
The only sector besides Tech to beat the S&P was Telecommunications, with its internet infrastructure plays like Lucent and Global Crossing.
If we go back exactly 22 years to 11/18/1999, we see that the Tech sector had more than double the return of the S&P since the inception of the SPDRS, yet it continued to outperform dramatically over the subsequent 4 months. I don’t know if Tech is once again entering a blow-off bubble top, or if the subsequent decline will be as severe as it was in 2000-2002. What I can say is that generalizing Tech’s performance to “the market” was not helpful in late 1999. The other sectors held up well into the bear market and were still in the black during the second quarter of 2002, around 4 months before the bear market ended.
Looking ahead from today, history suggests that underweighting tech and overweighting the traditional defensive sectors is once again called for. Some best-of-breed stocks in these sectors could even survive the bear market with no downturn.
The following charts show the end of the tech bubble and the subsequent bear market that lasted until October 2002. I picked a somewhat arbitrary starting point of exactly 22 years ago, or 11/18/1999. To help think about what to do going forward, I wanted to show that it is possible to achieve a satisfactory outcome even if action is taken before the exact top. During the final blow-off bubble top, Tech and Telecom were the only outperformers while nearly all the other sectors were negative. What followed was volatile but mainly sideways performance for the other sectors with the bigger dips in March of 2001 and again around 9/11. Nevertheless, every sector outside of Tech and Telecom had a day in which it was in the black as late as the second quarter of 2002. It was not until the final 3 months of the 18-month S&P bear market that these sectors were significantly impacted.
The table below summarizes the returns of each sector through the bear market and shows the last date on which the sector had a positive return relative to 11/18/1999. With the non-tech sectors still positive through the summer of 2002, there was no need to sell everything just because “the market” looked expensive in 1999.
While it was not its own sector 20 years ago, we can see from the Nuveen fund’s performance that Real Estate was an excellent performer during the tech bear market, returning 20% and never going negative. The traditional defensive sectors of Healthcare and Consumer Staples also held up relatively better through the whole bear market. Still, most other sectors held up well through the summer of 2002 and owning the best of breed in these sectors would have avoided significant losses.
John Templeton is quoted as saying “The four most dangerous words in investing are: ‘this time it’s different’.” Still, history does not repeat perfectly, so it is worth looking at what is different about the current environment compared to 1999. One place to start is interest rates. In November 1999, interest rates were high with the Fed Funds rate at 5.4% and the 10-year Treasury at 6%. The yield curve was high and inverted during 2000 and the Fed did not start easing until 2001 with the Fed Funds rate dropping quickly at first, then slowly until bottoming at 1% in 2003. Meanwhile, the 10-year only fell to 4%, meaning the yield curve steepened considerably which should help Financials and Real Estate.
Contrast this with the present scenario. Interest rates were already dropping in the back half of 2019, then went to rock bottom during the pandemic crash. Since then, the 10-year rate is showing signs of life with the tapering of quantitative easing just starting. If inflation becomes more persistent, the 10-year may keep increasing regardless of what the Fed does. In this way, we still get a steepening yield curve even though absolute rates are lower than 20 years ago. This is still good for Financials and not as good for growth sectors like Tech.
Moving to relative valuations, we also see many similarities with just a few differences. The numbers in the table below are forward P/E ratios from charts published by Yardeni Research. The overall market is only slightly less expensive now than it was at the start of 2000. Tech and Communications are expensive but under the extreme valuations of 22 years ago. This is explainable by current earnings at the now mature large-cap tech companies like Microsoft (MSFT), Cisco (CSCO), and Qualcomm (QCOM). It is also explainable by Amazon now being in Consumer Discretionary where it, along with Tesla gives that sector a higher valuation. Take away the mature tech names, and you see a picture much closer to 1999 in the Tech and Communications sectors.
Energy is much cheaper and Utilities much more expensive now compared to 1999. I would attribute some of this difference to the current market mania for alternative energy and revulsion toward fossil fuels. Like the tech bubble, the market sentiment can correctly anticipate the future yet greatly distort valuations in the present.
As with the overall market, the Financials, Consumer Staples, Materials, and Industrials are similarly valued now as they were in 1999.
Given the strong similarities to 22 years ago, I would of course underweight Tech and Communications. The only tech names I hold are low-multiple but well-established names like Qualcomm and Cisco. I do also hold Visa (V). That will soon be reclassified to Financials and I would not buy more here given its high valuation. I would also avoid the former tech names in Communications as well as the traditional telcos like AT&T (T) which does not look like a bargain despite its low multiple as I recently wrote.
Financials, Consumer Staples, and Healthcare look like buys due to both current valuation and relative performance during the last tech crash. My favorites from these sectors are Berkshire Hathaway (BRK.A) (BRK.B), PepsiCo (PEP), and AbbVie (ABBV). You can read more about my thoughts on Berkshire and Pepsi in recent articles. AbbVie uses its cash cows of Humira and the Allergan portfolio to cover its excellent dividend while developing its strong franchises in immunology (Skyrizi, Rinvoq) and oncology (Imbruvica, Venclexta). Berkshire and Pepsi both produced strong positive returns during the last tech bear market. AbbVie’s former parent Abbott Labs (ABT) also held up well.
Select areas in Real Estate should also do well, but I would be careful about buying the whole sector which worked in 1999-2002. Many companies that form the top holdings of XLRE are in high multiple tech-adjacent groups like cell towers, logistics, and data centers. I prefer VICI Properties (VICI), a casino REIT which is dominating its industry through an upcoming merger with MGM Growth Properties (MGP) which I own. VICI is also branching out into non-casino entertainment real estate like indoor golf and water parks. VICI’s valuations are still recovering from the pandemic while actual business is already booming. While travel could get hit again in the next recession, I expect leisure to hold up better than business travel. I wrote more about MGP and VICI last month.
Finally, I would have an allocation to gold miners. The metal itself proved to be a decent store of value during the tech bear market, although the miners did even better, especially Agnico Eagle (AEM). Personally, I am holding Barrick Gold (GOLD) which is much larger and more diversified than Randgold which held the GOLD ticker 22 years ago. The company is run by Randgold’s former CEO Mark Bristow who has gotten the company to a zero net debt position and turned around low-performing acquired assets like the Nevada Gold Mine JV it holds with Newmont (NEM).
The Technology sector’s run over the last three years and current relative valuation holds many similarities to the late 1999 Tech bubble which preceded the 2000-2002 bear market. If I were in any high multiple tech names (which I am not), I would look to scale out over the next few months. While many warnings of high valuations are heard now as they were 22 years ago, one should not take that as a signal to sell all their equities. Other sectors outside of Tech and Communications held up very well until just a few months before the end of the bear market. If another tech crash is coming, traditional defensive sectors like Healthcare and Consumer Staples should again hold up well, along with Financials, selected Real Estate, and gold mining within Materials. High quality stocks within those sectors may not even behave at all like they are in a bear market.
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Disclosure: I/we have a beneficial long position in the shares of ABBV, BRK.B, CSCO, GOLD, MGP, PEP, QCOM, V either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Surviving A Tech-Led Bear Market: Lessons From 1999 To 2002 – Seeking Alpha
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