Warning Signs Flash as Stock Market Soars to Records

Some Analysts See a Replay of the Go-Go Market of the Late 1990s

For some investors, it feels a lot more like 1999 than 2013.

Third-quarter earnings have not been spectacular. The U.S. isn’t expected to grow at anything close to breakneck speed next year. And there are few industries experiencing huge profit expansions.

Despite all that, a number of high-profile—mostly technology—stocks are soaring. The heady advances are making shareholders of these companies big money, but they’re also raising serious questions among some analysts about whether the unusual trading is a troublesome sign for the overall market.

Last week, the Dow Jones Industrial Average set a record on Tuesday, but closed up just 0.29% for the week. The Standard & Poor’s 500 stock index also set a record and rose 0.11%.

So far this year, the Dow has climbed 19%, the S&P 500 24% and the Nasdaq 30%.

Some hot tech stocks, including electric-vehicle maker Tesla, entertainment-streaming provider Netflix, travel site Priceline.com, and search company Google are doing much, much better. These stocks are up as much as 470% over the past year.

Other soaring stocks include social-networkers LinkedIn, which is up about 110% in the past year, and Facebook, up nearly 140%.

The expected initial public offering of Twitter this week likely will add to the frenzy.

Rising stocks usually create smiles on Wall Street, but these gains are also making some nervous.

When a select group of speculative stocks trading at huge multiples of their earnings—due to high expectations for future earnings—leads the market, it can be harder to sustain the gains than in a bull market led by companies with more-dependable earnings.

“It reminds me of the tech go-go years of the late 1990s,” says Jack Ablin, chief investment officer of BMO Private Bank.

Indeed, the recent gains in tech shares are reminiscent of the Internet-led bull market that created huge fortunes but ended in 2000 when the small group of expensive technology stocks that had powered the market higher suddenly collapsed, pulling the entire market down with it.

That’s not something investors want to be reminded of.

All of the current highfliers are getting investors excited for good reasons, including rapid customer expansions and strong growth prospects.

But many investors have cause for worry, too. Facebook, which reported better-than-expected third-quarter earnings last week, nonetheless spooked investors when it warned that U.S. teens are spending less time on the site and that the company might not be able to cram any more ads into users’ news feeds.

As for Tesla, shortseller Jim Chanos has noted that the company’s high valuations—it’s trading at a price-earnings multiple of 297 times 2014’s expected profits—rest on forecasts beyond 2020 that no investor can reasonably project. Tesla has a market value of more than $19 billion, or close to 40% of the $51 billion value of the much-larger General Motors. But GM is expected to generate sales that are 75 times greater than Tesla’s this year.

“It’s fascinating to me that today’s mini-mania includes shares of Amazon, Netflix and Priceline that have previously peaked and crashed before—in some cases they’ve peaked and crashed twice before,” says Darren Pollock, portfolio manager at Cheviot Value Management. “Stocks like these have again captured the imagination of speculators. We’re skeptical that there is enough underlying intrinsic value to many of the highfliers to support today’s prices.”

Mr. Pollock is also concerned about the rush of companies selling shares as part of initial public offerings.

“You don’t see an explosion of IPOs like this at market bottoms,” he says. “Bull markets peak when speculation centers around a narrowing number of highfliers amidst elevated share issuances by companies and expanded use of margin debt. We have all three.”

In almost every market there are certain stocks that soar, of course. The difference is that those are usually turnaround stories, some with improving earnings, and few are as expensive as today’s tech stars.

There are other reasons investors are becoming a bit more cautious. While home prices rose in August from a year earlier at the fastest pace since February 2006, the gains slowed in September—suggesting that prices are peaking.

“Our view remains that national home prices will continue to rise,” says Peter Newland of Barclays. “That said, this report may hint at the beginning of an easing in the pace of price gains.”

As for third-quarter corporate earnings, they’ve been respectable—but nothing to write home about. Profit growth remains slow and steady. Third-quarter profit growth among S&P 500 stocks is expected to be about 4.5%, and companies are beating a low bar set by analysts, investors say.

Still, some analysts say the overall market is reasonably priced, no matter how expensive a few sexy stocks appear.

The S&P 500 trades at a reasonable multiple of 15 times expected earnings over the next 12 months. Unlike 2000, the stock market doesn’t seem in a precarious position, based on price/earnings ratios and other metrics.

There’s “a little frothy speculation around the edges, but overall technicals still remain reasonably healthy,” says Mr. Ablin.

“One big difference this time is that nearly 100 stocks of the S&P 500 are making new highs along with the index,” he says, suggesting that many stocks are joining in the climb, a healthy sign for the overall market.

Tobias Levkovich, Citigroup’s chief U.S. equity strategist, argues that there’s a healthier mind-set among investors today than in 2000. He says he’s cautious but isn’t telling investors to dump stocks.

“I’m concerned that earnings guidance has been relatively soft—there’s a real divergence between what the market is doing” and what companies are reporting, Mr. Levkovich says. “And I do see a certain level of complacency, but it’s not exuberant.”

Bookmark the permalink.