Wall Street Fears Over Stretched Stock Valuations as the Tech Sector Plunges

U.S. stock markets faced significant turbulence on Monday as major indices saw a mixed performance. Concerns about China’s AI startup DeepSeek disrupting profits for Big Tech firms rattled investors, adding to fears over the elevated valuations of these companies. This unease weighed heavily on the technology sector, which has been instrumental in driving market gains in recent years.

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The S&P 500 closed down 1.5%, while the Nasdaq Composite, heavily focused on technology, plunged 3.1%. In contrast, the Dow Jones Industrial Average managed a modest gain of 0.7%. The Roundhill Magnificent Seven ETF, which tracks seven prominent Big Tech firms, including Nvidia, Microsoft, Apple, Alphabet, Amazon, Tesla, and Meta, also declined sharply, losing 3.1% on the day.

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Kevin Gordon, a senior investment strategist at Charles Schwab, attributed the market's struggles to a “trigger moment” sparked by DeepSeek’s emergence. According to Gordon, this amplified existing concerns among investors about their overexposure to U.S. technology stocks, particularly as market behavior has shown signs of frothiness. He noted that this sentiment was reinforced by high valuations in the tech sector.

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David Kelly, chief global strategist at J.P. Morgan Asset Management, emphasized the importance of monitoring market valuations and portfolio concentrations, particularly given the recent run-up in stock prices. In a note, Kelly drew comparisons to the dot-com bubble burst in 2000, which led to a 47% drop in the S&P 500 over two and a half years.

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He highlighted that as of January 23, the S&P 500 was trading at 22 times forward earnings, significantly above its 30-year average, with the top 10 stocks in the index carrying a price-to-earnings (P/E) ratio exceeding 30.

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The dominance of Big Tech stocks in the S&P 500 has led to their outsized influence on the index. Barry Bannister, chief equity strategist at Stifel, pointed out that valuations typically become critical during extremes, adding that the current environment represents the fifth “mania” in U.S. stock market history over the past century.

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One of the biggest losers on Monday was Nvidia, which plunged 17%, though it remains up roughly 94% over the past year. Investors expressed concern over how DeepSeek’s rise could impact U.S. companies like Nvidia and Broadcom, both of which have benefited from the recent excitement surrounding artificial intelligence. Broadcom and Nvidia were the two largest holdings in the iShares Semiconductor ETF, which tracks U.S. semiconductor stocks and dropped 7.8% on Monday.

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The day’s turbulence was also evident in the Cboe Volatility Index (VIX), commonly referred to as Wall Street’s fear gauge. The index spiked 20.5% during the session, closing at 17.9. Such a surge indicates heightened investor anxiety about market conditions.

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Bannister cautioned that if the S&P 500’s P/E ratio has indeed peaked, the outperformance of large-cap growth stocks relative to value stocks may have also reached its limit. Historically, transitions from growth to value stocks have not been seamless, and Bannister believes economic conditions may favor defensive value stocks over growth equities as the year progresses.

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Value stocks demonstrated resilience during Monday’s selloff, outperforming their growth counterparts. The Russell 1000 Value Index edged up 0.3%, while the Russell 1000 Growth Index tumbled 2.9%. Gordon suggested that a strong labor market and overall economic stability could provide a solid foundation for value stocks to close the performance gap with growth stocks, which had surged significantly in 2024.

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Technology stocks were the worst-performing sector in the S&P 500 on Monday, plummeting 5.6%. This marked the sector’s worst single-day performance since September 2020. However, the broader market’s decline was less severe than it appeared at first glance. Gordon noted that the breadth of the market remained relatively healthy, with more stocks in the S&P 500 rising than falling on Monday.

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Despite this, the tech selloff wiped out an estimated $1 trillion in market value from U.S.-listed stocks across major exchanges, according to Dow Jones Market Data. Bannister warned that the dominance of Big Tech stocks, which account for 30.5% of the S&P 500’s market capitalization and 21.6% of its forward earnings, could pose significant risks. A disappointment in earnings from these companies, dubbed the “Mag-7,” could drag the entire index down substantially.

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The defensive value sectors may provide some stability in the face of potential market volatility. Bannister highlighted utilities, pharmaceuticals, biotech, healthcare, household products, and waste management stocks as examples of defensive value investments that could outperform in an environment of slowing economic growth and persistent inflation. However, even traditionally defensive sectors like utilities struggled on Monday, with the S&P 500’s utilities sector declining 2.3%, making it the second-worst performer after technology.

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Consumer staples, another defensive segment, fared better, leading sector gains with a 2.9% increase. Other sectors, including healthcare, financials, and real estate, also posted gains, highlighting some divergence in market performance.

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Looking ahead, investors will be closely watching the quarterly earnings reports of Big Tech firms like Microsoft, Meta, and Tesla, which are due out on Wednesday. This coincides with the Federal Reserve’s monetary policy meeting, a key event that could influence market direction. Bannister remains cautious, warning of the potential for stagflation and a 10% correction in the S&P 500 to around 5,500 later this year.

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Investor focus on Big Tech remains a double-edged sword. While these companies have driven significant gains, their dominance and high valuations leave the market vulnerable to corrections, particularly if earnings fail to meet expectations.

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