After a torrid 2022 that saw the Nasdaq lose over 30% of its value and nearly $4 trillion wiped off the market capitalisation of the biggest tech companies, the sector has had a good start to 2023. By mid-February the tech-heavy Nasdaq was up 13% for the year. Notably, tech stock gains were also driven by companies which suffered some of the biggest losses last year.

After announcing in early February revenue had shrunk by less than expected and that it would be able to cut costs by more than previously estimated, not exactly a bullish turn in fortunes, Meta Platforms saw its share price leap. While gains for the year-to-date have since slid back to 36%, at one point the owner of Facebook, Instagram and WhatsApp had seen its valuation gain 82% since the beginning of 2023.

Netflix was also up 18% a couple of weeks ago and still holds a 9% improvement for the year. Tesla saw its share price fall 65% in 2022 but it has soared by a massive 92% so far in 2023. Cathie Wood’s Ark Innovation ETF, which became a totem of the tech sector bubble when its share price hit $150 in late 2021 before slumping to $30 by the end of last year, is up 27.5% for 2023.

The cryptocurrency exchange Coinbase lost almost 90% of its value between a share price peak of $342.98 in late November 2021 and the end of 2022 when its stock was trading at $35.39. It’s up 75.5% for 2023 despite the “crypto winter” and U.S. regulatory authorities targeting the sector.

Is the tech sector recovery sustainable?

The positive momentum for tech stocks in early 2023 has been put down to hopes backed by inconclusive evidence that inflation has peaked and will now maintain a steady descent. That would in turn be expected to see the Federal Reserve and other major central banks around the world decelerate their recent pattern of steady interest rate rises.

Optimism that interest rates will have a lower high point than feared in late 2022 and the potential of them even being dropped again slightly if recession hits has buoyed markets. And following the pattern of the last decade or so, investors have quickly piled back into the tech sector in the presumed expectation it will again represent the vanguard of a new bull cycle.

However, a growing number of pragmatists are urging investors to show caution before jumping back into a sector and companies they have grown used to delivering market-beating returns. They argue that inflation may well prove a more stubborn foe than the optimists are betting on. And that the tech sector recovery of early 2023 may not only not be sustainable but could give way to new drops that will take valuations lower than they finished last year.

Why elevated inflation and higher interest rates may prove stubborn

Oil and gas prices have recently dropped to levels not seen since before Russia’s invasion of Ukraine a little more than a year ago. That’s helped take some of the air out of inflation over the past few months. However, central banks have continued to raise interest rates, far from reassured inflation levels that hit 40-year highs last year will drop quickly with easing energy costs.

A taut labour market pushing up salaries and spurring further inflation in goods and services despite lower energy prices is the biggest concern. At the beginning of February, unemployment levels in the USA were at their lowest level in over half a century and the jobs market is also historically tight in other developed economies such as in the UK and Europe.

That’s left central banks, especially the Fed, concerned that salary inflation will make overall inflation a more stubborn beast to tame than market consensus currently expects. On February 7, Fed chairman Jerome Powell announced the process of bringing inflation back to the target 2% “has a long way to go”. The same day Isabel Schnabel of the European Central Bank warned that underlying upward pressure on prices remained “extraordinarily high”.

As The Economist points out, while central banks are reducing the pace of interest rate hikes they are also extremely loathe to repeat the mistakes made in the 1970s when monetary policy was loosened only for inflation to surge again. As a result, central bankers look determined to remain hawkish on interest rates and favour a recession over loosening their grip on inflation if there is any evidence at all it still poses a potential risk.

The result could spell double trouble for equities markets, and especially growth stocks like many in the tech sector are still seen as. That would mean both a higher discount rate depressing risk-based asset prices due to higher guaranteed returns on fixed income investments and a higher risk of recession.

Gains made by tech stocks this year don’t seem to have fully priced that risk in.

Why recent tech stock gains could be nothing more than an echo of the deceased bull market   

The other concern less bullish stock market investors and analysts have is that the early 2023 momentum enjoyed by tech stocks, which may already be fading after declines since mid-February, is simply a “echo bubble”. In a recent column for the Financial Times, Rockefeller International chair Ruchir Sharma describes the phenomenon as “a brief rebound of the kind that has punctuated the long decline of every major bubble in the past century”.

He points out that while the bull market that lasted from 2009 until last year has been described as “an everything bubble” , it was in reality concentrated in a handful of sectors such as the largest tech stocks, both American and Chinese, and crypto. As such, he sees it as likely that stocks from the sectors that fuelled the stock market bubble that popped in late 2021 still have both further to fall and will take much longer to recover than optimists hope.

The best performing stocks and assets this year are those worst hit last year. Crypto and Bitcoin is up over 60%, Chinese tech more than 50%, “profitless tech” such as Lyft and Spotify 40% and clean energy (which includes Tesla) is up 20%. Big Tech represented by the Faangs is up more than 30%.

That, he fears, rather than a bone fide return to a bull market for tech stocks simply investors falling back into the familiar approach that worked for them for a decade. They are not yet ready to take the plunge and back new opportunities and so returning to the same trough, despite the fact there is little evidence to suggest it will be filled again to anywhere near the same extent.

He sees the current pattern of investor behaviour as a clear repeat of the bubble echoes that followed each of the 10 major stock market bubbles that have formed since the 1920s. Bubbles like the roaring 20s, the big US corporations in the 60s, commodities in the 70s, Japanese stocks in the 80s, U.S. tech stocks in the 90s and Chinese tech stocks and hyper growth U.S. tech stocks last decade typically see prices more than double during the last year of the bubble – a phase referred to as “melt up”.

The popping of each of those historical bubbles has been, like now, catalysed by central banks tightening monetary policy. Once prices fell by more than 35% there was no immediate return and they usually hit a bottom 70% below their peak and not for three years after the decline began.

However, the way down has also been historically interrupted by up to four echo bubbles which saw valuations rebound by at least 20% and often to 30% or more. However, within three months gains are usually given up.

Sharma thinks the current market trend closely tracks the same pattern as the echo bubbles that have followed historical melt ups. After the bursting of the dotcom bubble there were three echo bubbles, the most significant of which saw the Nasdaq gain 50%. However, after such a big fall the extent of echo bubble gains was illusory. After falling 70% from its peak after the dotcom crash, the Nasdaq needed to record gains of 250% to recover its losses. It did but the process took 15 years.

He also highlights that of the 10 historical market bubbles, four asset classes that fuelled them still haven’t regained their peak, including Japanese stocks and Chinese shares after they hit record highs in 2015. Of the six that did, the recovery took an average 15 years. Even Microsoft took 14 years to fully recover from the bursting of the dotcom bubble despite its impressive fundamentals and enduring position as a tech titan.

Sharma’s conclusion is that investors are more likely to realise better returns in sectors and stocks that were not part of the bubble of the past decade than by returning by those that were, which could face a long road to recovery.

Things could always turn out differently this time but the strong evidence the early 2023 positivity for tech could prove a “bubble echo” should be something investors consider carefully before returning to familiar tech stocks.