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As the U.S. and other global stock markets continue their impressive rise, particularly within the technology sector, analysts from BCA Research warn that we may be witnessing the final stages of a tech bubble, reminiscent of 1999.

A new research report, "European Investment Strategy - The 1999 Risk," draws stark parallels with past market excesses and outlines a crucial test that could determine the bubble's fate.

"Mega-cap growth stocks are once again leading the market higher. In the US, the Magnificent Seven, with the exception of Tesla, are responsible for the bulk of the S&P 500 gains so far this year," reads the report.

"The recent resurgence of mega-cap growth and tech names is reminiscent of 1999. Back then, those stocks were already furiously expensive and offered unattractive risk-reward ratios. Yet, they continued to surge, with the Nasdaq 100 climbing 126% from January 1, 1999, to its peak in March 2000. It took a wave of rate hikes and poor earnings by bellwethers such as Qualcomm to topple the market," it adds.

Images courtesy of BCA Research.

"The last time the S&P 500 rose for 14 out of the past 15 weeks, a correction followed," the report states, underscoring the precarious position of current market valuations.

This historical pattern suggests that a significant market correction is not just possible but probable, posing a critical test for the ongoing tech rally. BCA Research analysts further elaborate on the nature of this test, explaining that "a prompt rebound – a mild correction of 10% or less – will likely embolden risk-taking, as investors expect central banks to ease policy in 2024."

This resilience in the face of correction could signal continued investor confidence in the technology sector, potentially inflating the bubble further.

However, the report also cautions that this speculative expansion comes with heightened risks. "The market can remain irrational longer than you can remain solvent," BCA Research reminds investors, quoting the apocryphal words often attributed to John Maynard Keynes. This serves as a warning against complacency and speculative excess that have marked the late stages of previous bubbles.

Images courtesy of BCA Research.

The document points to increased volatility as a hallmark of these late stages, noting that "the VIX averaged 24 in 1999, compared to its level of 14 today." Such elevated levels of market volatility indicate investor sensitivity to potential shifts in monetary policy and economic growth, further contributing to the precariousness of the current market rally.

As for the key test facing the tech sector and broader markets, BCA Research emphasises the importance of investor reaction to upcoming market corrections. "How stocks respond to an upcoming correction will provide the most important near-term test as to whether stocks are entering a last phase of euphoria," the report states.

This reaction could either validate concerns of a bubble poised to burst or signal a possible continuation of the rally underpinned by central bank policies and investor sentiment.

Above: "In the Late 1990s, The VIX Rose With Stocks" - BCA Research.

"Global equities look increasingly bubbly, which threatens our key view that European stocks are near a cyclical peak. If the mania expands further, European tech will lead the European markets higher," says BCA Research. "The odds of a last surge in the tech/mega-cap bubble have increased tremendously."

BCA Research explains that in the late stage of a bubble, the riskiest plays on the underlying theme tends to move the fastest: investors rush into the assets that have lagged in the previous stages of the bubble, in the hope of unearthing the last gems. This rush pushes “the junk” to the front.

"European tech shares offer many of those attributes. This is not to say that Europe does not have world-class tech firms, but their equity performance has been subpar," says the report.