Between frothy valuations for some tech stocks, growing inflation-related risks and recent market behavior, there are plenty of good reasons for investors to think twice about indiscriminately buying dips in retail tech favorites. And perhaps also an argument or two for hedging.
But between mostly positive industry fundamentals and the discounts some quality companies are now available for, there are also good arguments for selectively going bargain-hunting during selloffs.
In the wake of Monday's tech rout, here's a look at a few things that I like about the tech sector at this crazy moment in time for equity markets, along with a few things that have me concerned.
Things to Like:
1. Enterprise Software, Security and Cloud Spending Remains Pretty Strong
It was a constant refrain during earnings season: Businesses are eager to spend more on software and cloud services to improve productivity and modernize their infrastructures. Something to that effect was said by the likes of Microsoft (MSFT) and Amazon.com (AMZN) , as well as by the likes of ServiceNow (NOW) and Atlassian (TEAM) ...and the numbers that they shared backed up their assertions.
There were also plenty of positive numbers and comments shared by security tech firms such as Palo Alto Networks (PANW) and Fortinet (FTNT) , as corporate efforts to prevent malware attacks/data breaches continue leading IT security spending growth to easily outpace total IT spending growth.
2. By and Large, Chip and Chip Equipment Demand Also Looks Very Good
Supply-chain issues -- sometimes their own, sometimes those of customers -- have led Texas Instruments (TXN) , Applied Materials (AMAT) and a handful of other chip industry names to post softer-than-expected numbers in recent weeks. But as the numbers delivered by the likes of Advanced Micro Devices (AMD) , Nvidia (NVDA) , Qualcomm (QCOM) and KLA Corp. (KLAC) drove home, the good times otherwise continue for chip developers and equipment makers.
Chip demand within end-markets such as cars, smartphones, cloud servers and gaming hardware still looks very good heading into 2022. And between chip demand, wafer shortages, greater manufacturing process complexity and government-subsidized efforts to localize more chip production, many chip equipment makers could have it good well beyond next year.
3. Tech Giants Look Poised to Spend a Ton on Capex Again Next Year
Meta Platforms (FB) guided last month for 2022 capex of $29 billion to $34 billion, a range that implies 53% to 79% annual growth. Meanwhile, Nvidia, Arista Networks (ANET) and a slew of other major suppliers to Internet/cloud giants (i.e., hyperscalers) signaled that they expect cloud-related sales to grow strongly again next year.
Aside from being good news for suppliers, the 2022 capex plans of tech giants are an encouraging sign regarding the confidence these companies have to make giant capital investments pay off over the long term -- even as they deal with potentially messy macro conditions in the short-term.
4. It's Not Hard to Find Growth Stocks Available at Reasonable Prices
Quite a few tech companies that saw demand inflect in 2020 have been hammered over the last couple of months. Often (though not always), these companies reported a slowing of growth as consumers got out of their homes more, with some also indicating they're seeing supply chain-related issues.
These selloffs have resulted in many of the affected companies sporting much more reasonable valuations today than what they sported two or three months ago (not always cheap, but definitely much less exorbitantly-priced than before). Names that come to mind include PayPal (PYPL) , Roku (ROKU) , Peloton (PTON) , Chegg (CHGG) and RingCentral (RNG) .
Factor in all of the other tech growth stocks that trade at far-from-crazy multiples (various small-caps, some chip developers and equipment makers, a couple of tech giants), and this environment is far from a hopeless one for buyers who don't want to pay through the nose for growth, even with all the froth that exists in some parts of tech.
Things to Be Worried About:
1. Many High-Multiple Retail Favorites Have Been Putting in Blow-Off Tops (Or Have Done So Already)
While valuations were already steep for many high-growth tech favorites going into this fall, they often got taken to another level in recent weeks, as charts for a slew of SaaS, fintech, EV/clean energy and perceived "metaverse" plays went parabolic.
Tesla (TSLA) , Rivian (RIVN) , Nvidia, Upstart (UPST) , Cloudflare (NET) ...take your pick as to which run-up was the most incredible (my choice would be Rivian, which at its peak was worth more than General Motors (GM) and Ford (F) combined). Regardless, surges like these, which in their final stages are driven in large part by speculators who couldn't care less about valuation and are simply looking to sell to a greater fool, usually end badly for latecomers, regardless of the quality of the company involved. And quite often, the carnage has spillover effects for peers that might not have run up quite so much.
2. Sector Breadth Has Been Deteriorating for a While
As Real Money's Helene Meisler has been pointing out, market breadth has been pretty bad lately, with the number of Nasdaq and NYSE stocks making new lows soaring over the last few weeks even as the indexes surge to new highs.
If one zeroes in on the types of the tech stocks that have been favored by retail investors since March 2020 (e.g., the tech giants, high-multiple secular growth plays and an assortment of more speculative names), the situation has been even more extreme over the last couple of weeks.
A long list of names that had been retail favorites have been clobbered post-earnings and seen additional selling pressure afterwards. As a result, the tech sector has been relying on a smaller and smaller number of stocks to deliver gains for investors. And as many others have pointed out, such narrowing of breadth has often been indicative of topping action, with the few remaining winners also tumbling during a selloff's final stages.
3. Short Interest Has Fallen to Historically Low Levels
Wells Fargo observed in late October that S&P 500 short interest has been at historic lows for much of this year. Likewise, Goldman Sachs recently observed that short interest for the median S&P 500 stock has been at the lowest levels since the Dot.com bubble in recent months.
Other signs that shorts have been running scared: Borrow rates have plunged (if not evaporated) for many of the most richly valued retail favorites, and some prominent short-selling funds have thrown in the towel. And anecdotally, I've seen many smart people who have been sounding bubble alarm bells partly or fully capitulate in recent weeks -- either saying something to the effect of "maybe this time really is different," or suggesting it could still be a while before the bubble bursts.
Aside from taking away the fuel needed for short-squeezes, the fact that shorts are running for cover in such a manner also might serve as a contrarian signal that market sentiment has gotten excessively bullish.
4. Inflation/Yield Headwinds Might Have Reached a Tipping Point
Between the October CPI print and recent polling data on inflation and the economy, we had already reached a point prior to this week where inflation fears were impacting both Treasury yields and fiscal and monetary policy expectations.
Now, with the White House having renominated Jerome Powell as Fed chief (as opposed to nominating the likely-more-dovish Lael Brainard), another shoe has dropped. Though Powell has overseen (to the bewilderment of those worried about inflation) an ultra-dovish monetary policy regime, it's worth keeping in mind that he was under immense political pressure to do so. With his renomination secured, Powell now faces much less pressure to act this way...and the prepared remarks that Powell and Brainard shared on Monday suggested the Fed will be more aggressive in dealing with inflation going forward.
All of this helps explain why Treasury yields soared and (more often than not) growth stocks tumbled following news of Powell's renomination. Though any such process will be gradual, the historic easy-money regime that fueled the historic asset-value inflation of the last 20 months might just be nearing its end.
(Microsoft, Amazon.com, AMD, Nvidia, Ford and Applied Materials are holdings in the Action Alerts PLUS member club. Want to be alerted before AAP buys or sells these stocks? Learn more now.)
