Market Insider

Tech stocks are the most overvalued relative to the market since 2009

Key Points
  • Technology stocks are trading at an 11 percent valuation premium to the broader market, the highest since 2009, but they are still 4 percent below their historic average, according to Bank of America Merrill Lynch strategists.
  • The strategists also note the valuation of the S&P 500 is at its lowest level since late 2016, with the recent decline in stocks.
Traffic flows down Broadway past the Nasdaq market site in Times Square October 17, 2002, in New York City.
Stephen Chernin | Getty Images News | Getty Images

Tech stocks valuations are trading at an 11 percent premium to the broader market, the highest spread since 2009, according to Bank of America Merrill Lynch strategists.

The tech sector is still 4 percent below its historical average, excluding the premium it had in the tech bubble. The S&P technology sector is up 7.6 percent year to date, while the S&P 500 has risen 1.5 percent. The tech-heavy Nasdaq is up 6.7 percent so far this year.

The reason is that technology has outperformed last year and this year, and its price gains have outpaced earnings growth.

Bank of America Merrill Lynch strategists said with the decline in share prices, the valuation of S&P 500 stocks has fallen to a level last seen in late 2016. That is based on the forward price-earnings ratio, which BofA says is now 17 times, still 11 percent above its long term average.

"We looked at what stocks people generally gravitate toward at the end of a bull market. In that sentiment driven part of the bull market, you typically see the momentum stocks with better secular growth prospects continue to gain favor in that type of market. It's one of the key reasons we think in the near term at least investors will want to own technology," said Daniel Suzuki, BofA strategist. "It's one of our overweight sectors."

The strategists also looked at other sectors and pointed out that consumer discretionary, which has outperformed the market since last year, is now trading at a 22 percent premium to the market, well above its historic 9 percent premium. As prices rose for discretionary stocks, earnings per share for the sector have fallen since late 2016, they noted.

Energy had looked very expensive compared with its historic valuations, but it's now trading just 4 percent above its historic average multiple as earnings continue to improve.

BofA also says the divergence in valuations continues to improve for companies within the S&P 500. BofA tracks that metric and says it is now at a 2009 high. "This suggests a wide array of opportunities to differentiate between cheap and expensive stocks," the strategists wrote.

They ran the data at the end of February, but tech's valuation is currently about the same, relative to the broader market after gaining earlier in the month and then selling off, with Facebook.