Valuations reach new highs since the dot-com bubble, can U.S. tech stocks withstand it?

The technology, media, and telecommunications (TMT) sector in the United States is the most important and dominant sector in the standard index, and its valuation, market concentration, and internal correlation are now sending warning signals comparable to those during the 2000 internet bubble.

According to Bloomberg data on August 7, the valuation of the US TMT sector has reached a new high since 2009, with a forward price-to-earnings ratio of 26.7 times, not only surpassing previous highs but also showing a significant deviation from historical averages.

At the same time, the risk of market concentration has risen to historical peaks. The total market capitalization of the TMT sector in the S&P 500 index accounts for as much as 44.2%, approaching the historical record of 44.7% set in February 2000. The largest 10 companies alone account for 33% of the index's market value.

A more direct risk signal comes from the rebound in stock correlations within the sector. This indicator is often seen as a precursor to market stress and has now risen above long-term average levels. Historical data shows that a significant increase in correlation often signals a market adjustment.

Valuation Premium at Extreme Levels

The high valuation of the TMT sector is built on extremely high growth expectations.

Currently, the sector's forward price-to-earnings ratio of 26.7 times is 8.7 standard deviations higher than the average level of 16.9 times from 2015 to 2019.

Bloomberg points out that one particularly alarming signal is that if the "seven tech giants" are excluded from large-cap stocks, the valuation bubble signs for the remaining companies in the TMT sector are even more severe.

Excluding these giants, the sector's price-to-earnings ratio has climbed to nearly 22 times in 2024 and currently stands at 24.4 times. This figure not only sets a historical high but is also 11.7 standard deviations higher than the average level from 2015 to 2019.

In contrast, the price-to-earnings ratio of the equal-weighted S&P 500 index, which excludes market capitalization weight effects, is only 17.9 times, highlighting the significant pull effect of large tech stocks on the overall index.

Whether the TMT sector can sustain its high valuation depends on whether its earnings growth can continue to outperform the market.

Data shows that the sector's earnings growth has consistently outperformed the overall level of the S&P 500 index since the third quarter of 2023. The market generally expects that the TMT sector's earnings growth rate will reach 11.8% in the second half of 2025, which is 1.8 times the overall growth rate of the index.

However, this advantage is expected to narrow significantly in 2026: by then, the TMT sector's earnings growth rate is expected to be 15.5%, while the overall growth rate of the index is 12.3%.

Analysts believe that as the earnings advantage of the tech sector is expected to narrow in 2026, the foundation supporting its high valuation is shaking, which may ultimately lead to a rotation of funds from tech stocks to other undervalued areas in the market.

Market Concentration Significantly Higher than Average

Currently, the market capitalization of the TMT sector in the S&P 500 index has reached the peak level of the tech bubble period, indicating a very high concentration risk in the S&P 500 index.

The TMT sector accounts for 44.2% of the market capitalization, which is not only significantly higher than the pre-pandemic level of 33.8% but also exceeds the long-term average of 26.7%.

Although the sell-off earlier this year temporarily suppressed its market capitalization share, investors were forced to return to tech stocks as the earnings of other sectors were hit harder.

It is noteworthy that there is a gap between the market capitalization share and the earnings share of the TMT sector. This sector contributed 38.1% of the earnings of the S&P 500 index, but the market capitalization share of leading companies such as the "Seven Tech Giants" (33.2%) is significantly higher than their expected earnings contribution share (approximately 25%).

Rising Internal Correlation May Signal a Pullback

The correlation among stocks within the TMT sector is increasing, which is often seen as a sign of market pressure.

Data shows that the overall correlation of the TMT sector last bottomed out in July 2021, with the previous low occurring in December 2017.

Before these two bottoms, the initial divergence in large-cap stock trading led to price adjustments approximately six months later. Coincidentally, the sector is facing pressure in early 2025, about six months after the low point in the summer of 2024.

Currently, the average value of the 26-week rolling pair correlation coefficient for the sector is 0.49, significantly higher than the low of 0.18 in 2024, and has exceeded the long-term average since 2010.

Historically, after the correlation bottomed out in December 2017 and July 2021, the stock market experienced corrections approximately six months later. The correlation bottoming out in the summer of 2024, followed by pressure on the sector in early 2025, further confirms this pattern