Why Are Tech Stocks So Volatile?
Tech stocks have experienced significant volatility in recent times, characterized by dramatic price swings that can be unsettling for investors. This volatility stems from a complex interplay of factors, including the inherent uncertainty surrounding the future of the technology industry, the speculative nature of investment in growth stocks, and the rapid pace of innovation.
At the beginning of the last century, many car companies emerged, but only a few, like Ford and Chrysler, survived and thrived. Similarly, today’s tech landscape is filled with companies vying for dominance, and it’s difficult to predict which ones will ultimately succeed. This uncertainty is the most significant contributor to the volatility of tech stocks.
According to Elroy Dimson, professor of finance at the University of Cambridge, the situation mirrors the early automotive industry. “If you go back to the beginning of the last century there were an awful lot of motor companies, and it was clear that automobiles were going to make a huge difference,” he says. “But almost every company went bankrupt, you didn’t know which company you should be buying.”
One of the primary reasons for this instability lies in the nature of tech companies. Many are focused on future growth rather than immediate profits, pouring resources into research, development, and expansion. This can lead to high valuations and high price-earnings ratios. As Susannah Streeter, head of money and markets at UK financial services firm Hargreaves Lansdown, puts it: “Tech shares are more volatile, they have high valuations and their price-earnings ratios are very high, and growth stocks are more sensitive to interest rate movements.”
Investors in tech stocks are often betting on future success, anticipating that today’s investments will yield substantial returns in the long run. This “jam tomorrow” mentality means that any news that jeopardizes this future growth can trigger a sharp sell-off, causing share prices to plummet. Conversely, positive developments, even if they don’t immediately translate into profits, can cause valuations to sharply increase.
Because of the aforementioned factors, share values can be dramatically affected by small shifts in growth expectations. Dimson notes that “small changes in growth expectation can lead to large changes in share value”, which can have a cascading effect on multiple companies within the same sector.
One of the factors driving volatility is the fast-paced change in technology. Innovative companies can quickly disrupt the business model of established firms. Moreover, because leaders in the technology space can change quickly, this adds to investor uncertainty.
The landscape is dominated by a few key players, often dubbed the “magnificent seven” in the US: Nvidia, Alphabet (Google’s parent company), Amazon, Apple, Microsoft, Meta, and Tesla. The concentration of market share among these firms means that events impacting individual companies can have outsized effects on the overall market. For example, Tesla’s sales have been hurt by factors, including controversy surrounding Elon Musk, who has become increasingly political, and also growing competition from Chinese electric car manufacturers.
Artificial intelligence (AI) is the current major tech trend, with many companies claiming to be at the forefront of the AI revolution. However, it’s unlikely that all of these firms will succeed. Robert Whaley, professor of finance at Vanderbilt University, notes that “AI is certainly contributing to tech volatility. The race is on.”
In conclusion, tech stock volatility is unlikely to disappear anytime soon. Investors must be prepared for wild price swings. The fast pace of innovation, the speculative nature of growth stocks, and the unpredictable nature of the technology industry all contribute to the inherent instability of the sector.
