Some of the hottest stocks on the market are technology stocks that have had years of potential growth brought forward by the COVID-19 pandemic. Zoom Video Communications (ZM 2.53%) became a household name, Shopify (SHOP 4.14%) has exploded onto the scene, and names like Tesla (TSLA +0.44%), Square (SQ 2.09%), and Wayfair (W 1.51%) have all seen their stock prices at least double this year. And it's partly because investors think the pandemic is accelerating the adoption of key technologies in society.
Before you assume these companies will grow for the foreseeable future, it's worth considering what the downside could be if life returns to a more normal state in 2021. Will you still be excited to set up a Zoom happy hour with friends and order a burger and fries from DoorDash before an at-home workout on your Peloton (PTON +4.58%) bike? Or are you going to cancel your Zoom subscription and go to your local watering hole to hang out with friends again, just like you did in February?
Image source: Getty Images.
Is this normal?
There's absolutely no question that technology has been used in new and innovative ways over the last six months. And companies that were hoping to grow their adoption rate have seen usage explode. Food delivery services, video conferencing, and online retail are just a few of the tech companies that have grown more than expected in 2020.
Using these new technologies has been great, but I want to be honest that I'm sick of Zoom calls. And I don't know anyone who wants to use Zoom more than they are today. Here are some reasons why the tech bubble may be on its way to bursting.
1. The pandemic brought revenue forward that may not be sustainable
The pandemic likely accelerated some technology adoption that was coming anyway, like more online shopping and remote work. But some of that growth may not be sustainable. Zoom is the perfect example here, showing an astounding 355% increase in revenue to $663.5 million last quarter. But is that sustainable after schools stop virtual classes, companies open offices, and bars and restaurants open to full capacity?
Peloton is another company where I question its growth rate. In the fiscal third quarter of 2020, it reported a 66% increase in revenue to $524.6 million as total subscribers increased 64% to 176,600. But dig deeper, and you'll see that average monthly workouts per subscriber have jumped from 11.7 in the first fiscal quarter of the year to 17.7 last quarter. People are stuck home working out rather than going to the gym, but is that sustainable once gyms are fully open safely?
These questions can be asked across the technology space. Sure, demand for a company's products may be up in 2020, but is it up because the fundamental demand is up, or is business doing well because of a very specific pandemic-driven increase in usage?
2. GDP is falling
Let's not forget that the underlying economic fundamentals aren't particularly good, despite the sharp rise in technology stocks. The stimulus money and extra unemployment benefits put a Band-Aid on what's going to be a lot of pain for businesses and workers. When life returns to normal, there will still be thousands of restaurants out of business, tens of thousands of small businesses shut down, and millions of people permanently out of work. That's not necessarily an environment for growth, even in the tech world.
US Monthly GDP data by YCharts
I worry that we haven't even seen the true economic effects of the pandemic now that stimulus funds are ending. And we may be in for significantly lower economic activity in the second half of 2020 than we saw a year ago, which isn't good for any company.
3. A lot of companies are going to finally throw in the towel
Speaking of businesses, a lot of smaller businesses have been skating by the last six months as demand dropped. Restaurants are the most clearly affected, but dentists, salons, photographers, event centers, and many more are having a rough year. And lots of companies will eventually throw in the towel.
For companies like Square and Shopify, that's a double-edged sword. On one hand, companies are trying their services as a way to stay afloat or adapt their business models. But on the other hand, they'll likely see lots of the small businesses they work with go out of business.
The cascading effects of small businesses closing up shop will be felt across the economy as well. Commercial real estate is already struggling in some places, and suppliers and employees will feel the pinch next. When small businesses aren't healthy, it's tough to have a healthy economy, and I don't see a lot of positive signs in the next few quarters for shops that have struggled during the pandemic.
4. Tech stock multiples are out of control
The market is currently pricing in a lot of growth for technology companies, and I pointed out above that that growth may not be sustainable. If tech companies disappoint even a little, the hammer could come down hard.
I mentioned that Zoom's revenue growth may not be sustainable, but that's just the start. Is Tesla going to continue selling cars as fast as it can make them if millions of people are out of work? Is online furniture going to be a hot business when the stimulus checks stop coming in and retail stores open? Is at-home fitness really going to replace the gym experience?
PTON PS Ratio data by YCharts
The multiples you see above show that investors are counting on a lot of growth in the future. And when investors get disappointed, the market can crash fast.
5. Someday, the easy money will end
If you read or listen to a lot of big investors, you'll hear that the current market is really fueled by the Federal Reserve. It's flooding the system with money to keep interest rates extremely low, reducing the return on bonds, real estate, and savings. Where else is the money going to go other than the stock market?
The Federal Reserve's reaction to the pandemic may have been the right one, but it can't keep money pouring into the economy forever without leading to inflation. Of course, some have been saying that for more than a decade and it hasn't come to fruition yet, but when the Federal Reserve punch bowl is pulled, it may cause a collapse we rarely see in the market. And investors don't know when the free money will run out.
6. This wouldn't be the first tech bubble to pop
In the 1990s, there was a similar euphoria about tech stocks. It didn't matter if a company made a profit or what price-to-sales multiples looked like -- investors would buy anything. We may be seeing something similar this year with tech stocks, fueled by special purpose acquisition companies (SPACs) buying up anything tech-related.
This bubble is very different from the 1990s because tech companies usually generate revenue and some are even profitable. But valuations are still out of control, and I wouldn't be surprised if a small disruption sends the entire industry lower.
Tech stocks have run too far too fast
Technology companies are disrupting a lot of what we do in our lives and changing how we work, communicate, and play. But that doesn't mean that every tech stock will grow forever or deserves a huge price-to-sales ratio.
I think the current bubble is starting to pop in tech stocks. Long-term, this is an industry with a lot of potential. But shares have risen too high too fast, and as we saw in the early 2000s, the tech bubble will eventually pop.
