Is UK Tech in a Bubble?

Is UK Tech in a Bubble?

Ray Dalio recently analysed US stock market prices and concluded that, while the economy as a whole is not currently experiencing a bubble, around 5% of America’s top 1,000 companies appear to be. Bubble pricing – which Dalio defines as “an unsustainably high price” for the company’s shares – appears particularly widespread in emerging technology companies. This is characterised by high share prices relative to traditional measures like earnings, unsustainable conditions being discounted by these prices, new buyers (particularly retail investors) entering the market in numbers, bullish sentiment, high debt levels and extensive speculative forward purchasing.

Renewable energy and related stocks such as electric vehicles appear to be the bubbliest corners of the emerging tech space, with Tesla’s share price increasing 700% through 2020 – an increase completely unjustified by the company’s underlying fundamentals. These kinds of prices imply an extreme amount of growth for the companies involved which could leave investors out of pocket in the event that they don’t deliver.

Dalio isolated the recent performance of the bubble stocks he identified and compared them to previous bubbles. Their market patterns mirror those of the “Nifty Fifty” of the early 1970s and the dot-com boom of the late 1990s, as well as the late 1920s bubble which led to the Great Depression. However, the number of companies affected, as a proportion of the total market, is only around half of that at the peak of the tech bubble.

Does this apply to the UK?

Dalio’s analysis only applies to US stocks, and in the absence of details of the methodology used it’s impossible to replicate the analysis for the UK’s tech market. However, it is possible to compare the rate at which UK tech shares have grown relative to the rest of the country’s economy, and compare this to the equivalent situation in the USA.

Finance house MSCI runs indexes that capture the performance of mid- and large-cap technology companies in the UK – the MSCI UK Information Technology Index (MSCI UK Info Tech) – and the US – the MSCI USA Information Technology Index (MSCI USA Info Tech) – as well as equivalent indexes for the countries’ economies in general. Through 2020, MSCI UK Info Tech fell 13.47%, almost the same amount as the MSCI United Kingdom index (13.23%). However, the MSCI USA Info Tech index gained 46.15% in 2020, while the MSCI USA only gained 21.37%. In other words, American tech share prices increased more than twice as fast as the country’s economy as a whole last year, while the UK’s tech scene mirrored the country’s economy almost exactly – and across both UK instances, stocks on average fell in price. This implies that the UK’s technology sector is, apparently, nowhere near as “bubbly” as America’s.

Nevertheless, a tech bubble in the US is not necessarily a good thing for the UK. The extent to which the two economies are interrelated, especially when considering IT infrastructure, is formidable, and a significant bubble bursting in the states would make ripples in the UK.

What does this mean for the UK’s innovators?

In the short term, perceptions of a bubble could be good news for the UK’s software houses as the overvaluation of American stocks, combined with a relatively weak dollar, will pull more US investment into British companies in search of returns. Over the long term, however, this could lead to the same over-valuation of UK stocks that appears to be creating a tech bubble in America right now.

It will be all about how different companies best manage the risks and opportunities created by the current landscape. We’re in a period of rapid transformation, which means the greatest innovators are in a fantastic position to change the face of their sectors for decades to come. But it also brings volatility and risks for those companies that don’t adapt quickly enough – this applies to their processes, their infrastructure, and their hiring strategies. Those that are able to attract investment while it is still in plentiful supply, and spend the money wisely, will be perfectly places to grow in the future.

Likewise, it's important that tech industry professionals stay ahead of any potential disruption by ensuring that, should a bubble form and burst, their skillset keeps them in demand if the supply of jobs should dip. For a snapshot of what we’re expecting to be the most in-demand technology skills and sub-sectors in 2021, see our most recent blog post.