There’s a Bubble Brewing in Plain Sight. Here’s How to Play It.

A lot of investors are talking about a “stock bubble” in the markets these days. I’m not here to convince you otherwise, because, yes, there is a bubble in the stock market… but it’s not what you might think.

black and white photo graphic of hand holding a pin up close to a floating bubble. The bubble has a green dollar sign inside of it.

The bubble in today’s stock market isn’t in hypergrowth tech stocks. Or energy stocks. Or housing stocks. Or cryptos. Or even bonds. There’s a bubble in Big Tech stocks.

Yep. That’s right. Big Tech stocks are in a bubble. The very stocks that have been the market’s biggest winners of the past decade, which seem invincible, and which have – for years – done nothing but go up…

Those stocks are in a bubble.

Simply consider that just five stocks – Microsoft (NASDAQ:MSFT), Nvidia (NASDAQ:NVDA), Apple (NASDAQ:AAPL), Alphabet (NASDAQ:GOOGNASDAQ:GOOGL), and Tesla (NASDAQ:TSLA) – are responsible for around one-third of the S&P 500’s 25% gain this year.

As the name implies, the S&P 500 has about 500 stocks. Just 1% of those stocks are responsible for 33% of the index’s gains in 2021.

That’s text-book “bubble.”

Why Big Tech Stocks Are in a Bubble

To be sure, huge past performance doesn’t necessarily mean those stocks are in a bubble. But unreasonably extended valuations do imply that – and, make no mistake, the valuations on Big Tech stocks are downright absurd these days.

Over the past five years, Microsoft stock has averaged a 27X forward earnings multiple. Today, it trades at 37X forward earnings – a near 40% premium.

Nvidia’s average forward earnings multiple over the past five years? 40X. Today, it sits at 57X – a 43% premium.

Apple’s forward earnings multiple is 31X – about 55% above its five-year-average.

These stocks are trading way above where they historically have traded on a price-to-earnings basis. Same is true on a price-to-sales basis, an enterprise-value-to-EBITDA basis, a price-to-book basis, and more.

Today, Big Tech stocks are as expensive as they’ve ever been.

Such extended valuations would be warranted if their growth trajectories were meaningfully improving, or market liquidity was improving. Neither is true.

Microsoft has grown sales at a 13% compounded annual growth rate over the past five years. Per consensus Wall Street estimates, that growth rate is projected to fall to 11% per year over the next five years.

Nvidia, meanwhile, has grown sales at a 27% compounded annual growth rate since 2016. That’s expected to drop to a 22% compounded sales growth rate over the next five years.

Apple has grown sales at an 11% annual clip over the past five years. Over the next five years, sales are expected to grow by 7% per year.

In other words, these companies are slowing down, and yet, their stocks are trading at their richest valuations ever. That’s a huge disconnect.

Such a disconnect could be explained by enormous liquidity injections expanding valuation multiples across the market. But that isn’t happening. In fact, the opposite is happening. The Fed is pulling liquidity from the market by tapering back its bond-buying program and is projecting rate hikes in 2022.

In other words, there really is no fundamental explanation for why Big Tech stocks are so richly valued today.

And that’s why I firmly believe Big Tech stocks are in a bubble.

How the Stock Bubble Will Change the Narrative of 2022

So, is there a bubble on Wall Street? Yes. But it’s in the stocks that no one is willing to bet against – Facebook, Apple, Nvidia, Microsoft, Google, etc.

I’m not telling you go and bet against Big Tech in 2022. No. Don’t do that. But what I am saying is that 2022 will be the year of small-cap stocks.

Because, while Big Tech stocks have run up to record-high valuations in 2021 despite slowing growth trajectories, small-cap stocks have plunged to record-low valuations despite accelerating growth trajectories.

The S&P Small-Cap 600 is currently trading at around 14.4X forward earnings, which is about 15% below its five-year-average forward earnings multiple. At the same time, the consensus Wall Street five-year-forward projected earnings growth rate for small-cap stocks has improved to about 20%, from about 12% before the pandemic emerged.

Therefore, I repeat, loud and clear, that 2022 will be the year of small-cap stocks.

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