The technology sector is off to a tumultuous start to the new year. After a rout last week, followed by a bounce over the last two days, where does that leave tech stocks?
Here are a few thoughts on where the tech sector stands following this rocky beginning to 2022:
1. There Are a Few Reasons to Believe We Haven't Made a Final Bottom Yet
It's possible that the strong bounce seen over the last two days will mark a temporary bottom for tech, given the heavy selling that preceded it. But I don't think we've reached a point of true panic/capitulation yet.
The Nasdaq is still up 3% over the last six months and more than 15% over the last 12 months. Many retail-investor favorites, including Tesla (TSLA) , Apple (AAPL) , Microsoft (MSFT) and Nvidia (NVDA) , remain comfortably above their September levels. Sentiment indicators, such as the Fear & Greed Index, the AAII Investor Sentiment Survey and the Investors Intelligence Bull/Bear Ratio, have registered only moderate upticks in bearish sentiment. And based on anecdotal observation and reports, there hasn't been a major increase in margin calls yet.
None of this suggests (for all the pain that's been inflicted on certain tech stocks) we've seen the kind of final washout one would expect following a period of incredible multiple-inflation and speculative excess in parts of the market.
2. Some Stocks Are Still Pretty Expensive - Particularly in a Rate-Sensitive Environment
Tesla is still worth over $1 trillion, Lucid (LCID) and Rivian (RIVN) are worth close to $150 billion between them, and (per my count) there are still 19 U.S.-traded software companies with $10 billion-plus market caps that sport forward EV/sales multiples above 20. There are also frothy valuations still to be found elsewhere in tech -- for example, among fuel cell and solar inverter makers, or among select high-growth Internet companies and chip developers.
And in an environment featuring rising interest rates/Treasury yields (fueled by high inflation and the policy responses it's producing), valuations that can only be justified by expectations of major earnings/cash-flow growth many years into the future look especially vulnerable to further compression.
3. Broad Rotational Actions Have Helped Create Some Bargains
As many readers are likely aware, it's not just the ultra-expensive tech stocks that have been hit by recent selloffs, even if they've typically been stung more than others.
There have been days when small-cap tech stocks (a group of companies that definitely includes a lot of cheap and moderately priced names) have collectively sold off hard. There have also been days when cheap Internet and software stocks were dragged lower amid broad, sector-wide selling. And there were also some days recently that saw rotations out of chip stocks (both expensive and not-so-expensive ones) into other parts of tech.
The crude and non-differentiating nature of these rotational flows has arguably been producing some asset mispricing. That in turn creates opportunities for patient investors willing to stomach some more short-term volatility.
4. It's Worth Staying Mindful of What Might Happen After the Omicron Wave Subsides
Right now, the number of daily Covid cases being reported in the U.S. is more than three times higher than the number reported during last winter's peak and more than four times higher than last summer's peak. However, hospitalizations are only about 20% above the summer peak and haven't yet reached last winter's peak -- and this is with a large percentage of Covid hospitalizations now involving people who were admitted for non-Covid reasons and either had mild symptoms or were asymptomatic.
The fact that Omicron is less likely on average to produce severe illness than prior Covid variants, together with the widespread availability of boosters and the fact that Omicron looks poised to infect a large percentage of the population in a short amount of time, raises the possibility that reopening activity could take off in a big way two or three months from now, after the current wave subsides. That in turn could spell a surge in consumer services spending (and with it, higher services inflation and even tighter labor markets), as well as numerous office reopenings and additional demand moderation for various tech businesses that saw their sales soar in 2020/2021.
It looks like bond markets and some reopening stocks have already begun pricing in this reopening scenario. But if it plays out in full, its effects on financial markets have probably only begun to be felt.
5. A Bias Towards Highly Profitable Companies Might Be a Good Idea for Now
Among the tech stocks that are now cheap or moderately priced, one can find a lot of companies that can be easily valued based on their earnings and/or free cash flow (FCF) estimates for the next 12-24 months. However, one can also find some unprofitable or lightly profitable growth-stage companies that could generate significant earnings/FCF a few years from now. Think enterprise software firms that are making large sales and R&D investments to drive strong long-term sales/billings growth, or some beaten-up SPACs that are expected to see their sales ramp significantly in the 2024/2025 timeframe.
Of these two types of inexpensive companies, it might be better for bargain-hunters to have a bias towards the first type of company for the time being. With markets on edge about inflation/Fed tightening and taking an increasingly risk-averse stance towards long-duration stocks -- even stocks that don't look all that expensive when a discounted cash flow model is run -- cheap companies able to currently report substantial profits/cash flows might fare better than ones that can only promise such profits/cash flows will arrive in a few years' time.
(AAPL, MSFT and NVDA are holdings in the Action Alerts PLUS member club. Want to be alerted before AAP buys or sells these stocks? Learn more now.)