For some time, various interpretations of the collapse of large-scale US technology stocks have emerged one after another, such as "the second blockade is coming", such as "the hope of a new round of stimulus is fading". For example, "the international situation is not good for big technology companies" and so on, but the more tricks you explain, the further you may deviate from the topic. The really most powerful answer is often the simplest-the process of mean regression will begin sooner or later.

What is the really most powerful force in financial markets?

The answer is mean reversion, meaning that while stock and bond prices may be extremely high or very low for a period of time, they will sooner or later return to long-term normal levels.

Recently, the technology sector in the US stock market has plummeted, sending the market lower, which is a classic example-now, the gravity of economic fundamentals has finally played a role, pulling back share prices that have flown into the air for half a day. bring its ratio to earnings closer to the traditional height.

For some time, various interpretations of the slump have emerged one after another, such as "the second blockade is coming", such as "the hope of a new round of stimulus is fading", such as "the international situation is not good for big technology companies" and so on. But the more tricks you explain, the farther away you may be from the topic, and the most powerful answer is often which one is the simplest-the process of mean return will begin sooner or later.

If you combine the ten largest stocks in the Nasdaq 100 index into one, assuming that this is a stock from a company called "tech star", then since the close of trading on Sept. 2, its total market value has fallen from $10.47 trillion to $8.76 trillion, a full loss of $1.7 trillion or 16.4%, equivalent to more than 1/8 of Microsoft Corp's current market capitalization.

After falling so much, some investors may wonder if the time has come to bottom. However, a more reasonable answer may be that the mean return has only just begun and there is still a long way to go.

This is because the rise experienced by tech stars before is so amazing that they are not afraid of falling so much and have not changed from "extremely expensive" to "slightly expensive". If you don't believe it, look back at the beginning of the stunning run a year ago, on September 30, 2019.

At that time, the ten stocks corresponding to "technology stars" were Microsoft Corp, Apple Inc, Amazon.Com Inc, Alphabet, Facebook Inc, Intel Corp, Cisco Systems system, Adobe Inc, PayPal Holdings Inc and Tesla, Inc. according to their market capitalization from high to low (although they are nominally automobile stocks, they should be listed as technology stocks in terms of their self-positioning and market valuation). Since NASDAQ includes both Class An and Class B stocks of Alphabet, this "club" actually has 11 members.

"Tech Stars" had a market capitalization of $5.833 trillion at the time, and GAAP net profit for the previous four quarters was $224 billion, which means a price-to-earnings ratio of 26, up from 19 in 2015. but it's still about the same as the average over the past five years.

From September 30, 2019 to September 2, 2020, the membership of the tech star club has changed. Intel Corp and Cisco Systems are out, Netflix Inc and NVIDIA Corp are replaced, which must be emphasized. because the ratio of profits of the first two to their own valuation is much higher than that of the latter two.

During the 11-month cycle, the wealth of tech stars soared, reaching a peak of $10.47 trillion, almost doubling. The problem is that profits have not kept up. In fact, they are down 6% from 11 months ago, to $210 billion.

Prices have skyrocketed and earnings have shrunk. As a result, the price-to-earnings ratio has changed from 26 to 50. For example, Apple Inc's price-to-earnings ratio expanded from 19 to 40, while Microsoft Corp expanded from 29 to more than 40.

Although the tech star's share price fell 16 per cent over the next three weeks, it is still valued at $8.76 trillion, 50 per cent higher than nearly a year ago, a price-to-earnings ratio of 41.7 and roughly 50 per cent higher than the average since 2015.

What does it mean for investors if the price-to-earnings ratio of tech stars eventually shrinks back to the average of 28 in the mid-to-late 2010s? At present, the dividend yield of tech stars is 0.32%, which is almost negligible.

Let's assume that tech stars spend half of their earnings on share buybacks, which could increase earnings per share by 1.5% a year. Taken together, dividends and buybacks provide a return of about 1.8 per cent a year. At the same time, you might as well optimistically expect overall profits to grow at an annual rate of 10%, higher than the average of the past five years.

Under this assumption, the profits of tech stars will rise from $210 billion to $338 billion by the fall of 2025. Based on the aforementioned normalised price-to-earnings ratio of 28, the market capitalization would be $9.5 trillion, a mere 8 per cent higher than today's $8.8 trillion.

That is to say, including dividends and buybacks, investors can earn an average annual return of 3.4% over the past five years. This kind of calculation just proves how powerful the mean regression is.

What's more, we should not forget that, as mentioned earlier, the real growth rate of overall profits is unlikely to reach 10%, or even inaccessible. After all, big technology companies are putting an astonishing amount of money into stock buybacks, rather than driving future business development. This means that there is a higher possibility of zero or even negative return on investing in them in the next five years.

Of course, these big tech stocks may also rebound or even hit new highs in the process, but in the final analysis, the mean return will have the last laugh, which has been proved many times in history.