The 'Seven Sisters' - Is a tech bubble replaying? Goldman Sachs: This time is different.

Benefiting from the AI boom, the "Seven Sisters" of the US stock market have driven the Nasdaq and Pro UltrPro Shrt S&Pro 500 to historic highs, with gains of approximately 10.25% and 8.54% respectively year-to-date.

After experiencing a wild ride, the market is now showing signs of caution towards the "Seven Sisters". The market's concern is whether the US stock market's "Seven Sisters" are heading towards a tech bubble replay?

On March 1st, David Kostin, Chief Equity Strategist at Goldman Sachs, pointed out in a report that the current market differs from the bubble period in the following ways:

1. The number of overvalued stocks is lower than the peak in 2021, and investors are now more focused on the valuation and fundamentals of large-cap growth stocks, rather than blindly chasing growth, reducing the overall market bubble risk.

2. Compared to the late 1990s, the current valuations of the US stock market's "Seven Sisters" are reasonable because their strong fundamentals support their high valuations.

The "Seven Sisters" are not a tech bubble replay

Kostin used fundamental analysis tools to compare the valuation of the US stock market in 2024, 2021, and the late 1990s dot-com bubble period. He found several key differences in the tech stock rally in 2024 compared to 2021 and the late 1990s:

1) Significant decrease in the Enterprise Value-to-Sales ratio (EV/Sales): EV/Sales is a measure of a company's valuation, with a higher EV/Sales ratio indicating a higher valuation.

In 2024, stocks with EV/Sales ratios exceeding 10 times accounted for 24% of the total market value of the US stock market, while during the tech bubble periods in 2021 and the late 1990s, this proportion was 28% and 35% respectively. This indicates that the number of highly valued stocks has significantly decreased compared to 2021 and the late 1990s. Kostin stated:

"In 2021, many investors pursued high-growth company stocks without paying much attention to their valuation. However, the current market is more discerning, investors are focusing more on the quality and fundamentals of large-cap growth stocks, willing to pay a premium for the largest growth stocks in the index, rather than being willing to pay high prices for all growth stocks, which may reduce the overall market bubble risk."

"The current market dynamics are more similar to the tech bubble period, but compared to the late 1990s, the valuations of the US stock market's "Seven Sisters" are reasonable, because their strong fundamentals support their high valuations."

2) Increase in the cost of capital (i.e. the implied weighted average cost of capital of Pro UltrPro Shrt S&Pro 500): The cost of capital dropped to 3.8% in 2021 but has now risen to 5.7%, leading to higher financing costs for companies.The rise in the cost of capital has changed investors' investment preferences, making them pay more attention to the company's profitability, as only profitable companies can bear higher capital costs.

At the same time, the increase in the cost of capital has also led to poor performance of small-cap stocks, as smaller companies typically rely more on external financing, making them more affected by the rise in capital costs. These changes have led to adjustments in market structure, different from the situation in 2021.

Kostin predicts that the cost of capital will remain above the average level of the past decade, meaning that the valuations of small and unprofitable growth stocks are unlikely to return to the levels of 2021.

Furthermore, since the beginning of the year, the impressive gains driven by the Magnificent Seven have forced Wall Street strategists to raise their forecasts for the Pro UltrPro Shrt S&Pro 500 by the end of 2024. For example, Savita Subramanian, a strategist at Bank of America, recently raised the target for the Pro UltrPro Shrt S&Pro 500 from 5000 points to 5400 points.