UBS Heavyweight: "Warning Signal" for US Tech Stocks

In this round of the bull market led by US technology stocks, the debate on the "bubble theory" on Wall Street is intense. Is the technology stock sector currently risky?

In a report on Thursday, UBS pointed out that the technology sector is now entering the latter half of its outstanding performance, and the profit growth of the US technology industry may peak in the second quarter of 2024, after which it may slow down.

This does not mean that UBS believes the outlook for technology stocks is dim. UBS continues to be optimistic about software stocks, believing that software is not only a defensive investment but also a cyclical investment during economic growth.

However, the semiconductor industry has more "warning signals". UBS pointed out some profit and high valuation risks, but overall, the semiconductor industry still performs well in terms of profit growth and fundamentals, with no signs of overall overinvestment.

Four Major Warning Signals for Technology Stocks

UBS pointed out that the proportion of technology stocks in the US stock market value is higher than any other industry in the past, and it currently seems more like 1997:

With the expectation of productivity growth brought by AI, the market has met 5 or even 7 of the 8 conditions for the formation of a bubble, which means the market is on the edge of speculative excess.

If the market is entering a bubble phase, it is more like 1997 than 1999. 1999 was the peak of the previous technology bubble, which burst in early 2000, leading to an 83% plunge in the TMT industry from its peak.

UBS pointed out the "Four Major Warning Signals":

1. From the perspective of price momentum, the market is in an extremely overbought zone (mainly in the semiconductor industry rather than the software industry), with a 60% chance of some form of correction.

2. The gap between technology and non-technology earnings per share has reached its peak, with a projected year-on-year increase of 42.5% for the technology sector, slowing to 12.2% by the third quarter of 2024, while the earnings per share increase for other market sectors is projected to be -0.2%, rising to +13.1% by the fourth quarter of 2024.

3. Decoupling from the trend of long-term bond yields, although a rise in long-term bond yields is usually seen as a negative signal for the stock market, technology stocks have outperformed the overall market. This divergence has been present over the past year, indicating a need to pay more attention to the profit growth trends and related risks of technology stocks.

4. Economic slowdown, when the ISM new orders index rises, the technology sector may benefit. However, as economic growth expectations slow down, the ISM new orders index may also decline, posing a challenge to the technology sector.

Software: Less "Bubble", Expected to Continue Rapid Growth

Whether as a defensive asset or a cyclical investment during economic growth, the software industry has always been UBS's favorite. In addition, stable growth and its key role in the field of AI also contribute to the earnings of software stocks For the software industry, UBS only saw two slight warning signals:

1. The position is crowded. According to QuantAnswers data, the software industry's position is crowded, but not significantly different from the average level of the past 8 months.
2. The speed of profit expansion seems to have peaked, but profits are still increasing.

UBS sees more positive factors:

1. Limited profit risk. Although the profit growth rate is slowing down, we are still receiving profit upgrades, with earnings per share slightly below the trend level. The software industry has always been the fastest-growing industry in the market (with a compound annual growth rate of 10%).
2. Software stocks are obviously not overbought.
3. The valuation of the software industry is still reasonable. Based on the price-earnings ratio relative to the market level, there is an 83% chance that the software industry will outperform the market in the next 3 months.
4. The balance sheet is robust.
5. Software is slightly undervalued on the market narrative radar. We use Sean Simonds' market narrative radar and found that software is slightly undervalued.
6. It has risen 8 places on our global scorecard, ranking seventh.

Semiconductors: Greater Risks, but also Positive Factors

UBS pointed out more risks in the semiconductor industry:

1. Profit risk, with profits 15% higher than the trend level, indicating the risk of overheating in the industry.
2. Overvalued, with a price-earnings ratio close to pre-recession highs, with a ratio of about 6 times the expected market value to TAM in 2030, and price-earnings and price-sales ratios are at extreme levels.
3. The brand on our global scorecard has dropped 6 places, ranking 15th out of 24 industries.
4. The pace of profit growth is slowing down. Profit growth is still the strongest among all industries, but expectations for future profit growth are stabilizing or weakening, with significant discrepancies between performance and expectations.
5. Compared to the software industry, the semiconductor industry has a relatively high buy recommendation.

Despite the risks in the semiconductor industry mentioned above, the UBS report also mentioned some positive aspects, such as strong profit growth in some companies in the industry, high quality of the scorecard fundamentals, and no signs of overall industry overinvestment. In addition, the semiconductor industry's revenue accounts for only 0.6% of global GDP, slightly above the trend level.

UBS holds an optimistic view on the growth prospects of "Chip King" NVIDIA, giving it a "Buy" rating with a target stock price of $1100: NVIDIA is the only chip company that can create its own market. Looking at the relative P/E ratio, the stock is not expensive (the P/E ratio is in the middle of its historical range), but the problem lies in the fact that even the multiple of sales four years later looks very high in the January 2028 forecast, reaching 15.5 times.

UBS advises investors to be more cautious when choosing semiconductor stocks, leaning towards companies with lower valuations. UBS also expressed a preference for TSMC, believing that TSMC has significant advantages in technology and market share