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UPDATE: Tech stocks plunge amid bubble fears after 'mania' drove S&P 500 to peak

The S&P 500 took a sharp, tech-led downward turn Sept. 3 after nine record-high closes in the last 12 trading days, igniting fresh speculation over whether U.S. equities are a bubble that is about to pop.

The benchmark U.S. equity index closed more than 3.5% lower Sept. 3 at 3,454.89, with the IT sector down 5.83%. Apple Inc. slumped 8%, and Alphabet Inc. slid 5.1%, keying the Nasdaq Composite Index to a 5.0% drop.

The decline Sept. 3 came amid increased options volatility and overstretched valuations for the mega-cap tech stocks, said Fawad Razaqzada, a market analyst with ThinkMarkets.

"Today's big drop serves as a reminder that the markets can actually go down as well as up," Razaqzada said in a note. "Investors speculating on further gains for technology names will now have second thoughts about investing at these still-elevated levels."

Before this pullback, the recent stock rally had pushed the large-cap index to 5.7% above the Feb. 19 peak that preceded the pandemic crash.

"US equities ... trade at truly record valuations, a full-blown mania," said Kevin Smith, founder and chief investment officer of Crescat Capital. "Ongoing policy rescue has perverted both free-market accountability and price discovery, creating a simultaneous zombie economy and stock market bubble, which is unsustainable."

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The S&P 500 gained 7.2% in August on a total-return basis, which includes reinvested dividends, according to S&P Global Market Intelligence data. It was the index's best August since 1986 and best overall month since April.

Buoyed by massive tech companies, the IT sector led the way with a 12% total return. It was the third time in four months that tech stocks led the large-cap index. Consumer discretionary and communication services stocks were the second- and third-best-performing sectors in August, up 9.5% and 9.1%, respectively.

Utilities lost 2.6% in August, and energy stocks continued to underperform, losing 1% in August. For the year through August, utilities were down 6.7% and energy down 39.3%, while IT gained 36%.

Growth running out of room?

The tech run-up and possible bubble could also signal a change afoot in the performance of stock trading strategies.

Growth stocks again drove performance as the S&P 500 put up its records in recent weeks, but big tech shares' lofty valuations are leading to concerns about just how long this investing strategy's run of dominance can last.

Stocks that align with growth-focused trading strategies achieved returns of 9.4%, while momentum stocks returned 8.1% in August, according to S&P Dow Jones Indices data.

Apple Inc., Microsoft Corp., Amazon.com Inc. and Facebook Inc. are the four biggest constituents of the S&P 500 Growth Index and combined account for a third of the total weighting. The four tech giants saw their share prices rise by 21.4%, 10.0%, 9.1% and 15.6%, respectively, in August.

"Growth stocks have benefited from stronger and more resilient earnings growth, as well as a tailwind to valuations from loose monetary policy," UBS Global Wealth Management’s Americas CIO Solita Marcelli wrote in a market commentary. "However, our equity analysts expect these trends to ebb in the coming months, which could lead to value outperformance."

After August's gains carried over for two more days, the big tech growth stocks led an equity market retreat Sept. 3. In addition to Apple's and Alphabet's slides, Microsoft fell 6.2%, Amazon lost 4.6% and Facebook was off by 3.8%. The Growth Index lost 4.5%.

"Now the question becomes: Is this the beginning of a correction?" Andrew Brenner, head of international fixed income at NatAlliance Securities, said late in the Sept. 3 trading day. "Heck, Nasdaq is already half way there today alone."

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For the year through August, growth and momentum dominated, with growth returning 25.5% and momentum pulling in 21.4%.

Most other trading strategies lagged far behind. Seven of the eleven strategies tracked by S&P Global Market Intelligence for this article delivered negative returns for the year through August.

High volatility

Since the S&P 500 started its run of records Aug. 18, the Chicago Board Options Exchange Volatility Index, or VIX, has risen 23.5%, from 21.51 to 26.57 on Sept. 2. While this is still well below the VIX's 82.69 high, set March 16, it is an unusual increase in Wall Street's "fear gauge" during a rally, according to Chris Bennett, director of index investment strategy at S&P Dow Jones Indices.

"Normally, an all-time-high in equities indicates a surefooted market," Bennett said in a Sept. 3 note.

The VIX has historically averaged 14.6 when the S&P 500 reaches an all-time high, Bennett said. The VIX's 26.57 close Sept. 2 was the highest the indicator has ever been on a day an S&P 500 all-time high was set, Bennett said.

"In short, stock prices may have already chosen their direction of travel, but VIX is sounding a clear warning that it may have been the wrong one," Bennett said.

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The bullish view

The S&P 500 may be the middle of a secular bull market, a state characterized by prolonged super-cycles and above-average returns for roughly 18 years, Jurrien Timmer, director of global macro for Fidelity, said in a Sept. 1 note.

If that is the case, the February-March downturn was a mere blip on a long upward path that has been charted for the past 11 years, and any bubble burst in the near future would leave several more years to dig out.

Timmer said the secular bull market is supported by accommodating monetary policy from the Federal Reserve, which has pushed investors from government bonds into equities, and a weaker dollar, which is bullish for stocks and hard assets.

"Cyclical downturns during secular bear markets are agonizingly long and deep and take a long time to unwind," Timmer wrote. "But cyclical downturns during secular bull markets are fast and furious and recover very quickly." The most recent bear market was the shortest in history, lasting from Feb. 19 to March 23.

The bull market faces several challenges, said Bruce Bittles, chief investment strategist with Baird, including a slower pace of economic recovery, uncertainty over both the spread of the coronavirus and the likelihood of additional federal stimulus, U.S.-China relations, and the upcoming presidential election.

“But with the most accommodative Federal Reserve in history and with the economy steadily improving, we believe market pullbacks will be limited in both time and price,” Bittles said.