Just maybe, tech stocks are at a crossroads where there's both too much optimism among die-hard bulls convinced that every dip in the shares of tech favorites is a buying opportunity, as well as too much pessimism among die-hard bears convinced that we're on the verge of financial armageddon.
Here are a few thoughts on where the tech sector stands, and what might lie ahead, after a wild Monday during which equity markets were hammered amid growing China-related fears, before bouncing a bit in late-Monday and early-Tuesday trading.
1. Evergrande Doesn't Have to Be the Next Lehman for China's Economy to Become an Issue
I won't pretend to be an expert about China's economy or its debt-laden real estate sector. But from what I've read and heard in recent weeks, many of those who have followed the space closely generally believe the following:
- Overleveraged property developer Evergrande is pretty unlikely to be China's Lehman Brothers, particularly since Beijing controls the counterparties needed to lend to/bail out the company.
- With Beijing intent on deleveraging its massive real estate sector, curbing widespread real estate speculation and making investors and debtholders in Evergrande and other property developers pay a price, the financial pain inflicted on Evergrande and its peers will likely have ripple effects for the broader Chinese economy and perhaps also global economic growth.
"There is a paradigm shift going on right now where China is willing to accept lower growth in order to de-risk the system," said China Beige Book CEO Leland Miller during a Monday interview. Considering how Beijing has thus far allowed Evergrande to twist in the wind and spread turmoil to financial markets, that looks like a fair assessment from the cheap seats.
And all of this is happening at a time when Chinese macro data has already been softening, with retail sales, factory output and lending growth each falling short of expectations. It's also happening as Xi Jinping & Co. make a broader effort to exert more state control over China's economy -- an effort that has already (to Beijing's apparent indifference) wreaked havoc on the shares of many Chinese tech companies.
Together, these developments should probably give some pause to U.S. companies with significant Chinese sales exposure -- including tech companies that directly or indirectly depend on China for a large portion of their hardware, software or chip/component sales. The sky isn't falling in China (at least, it doesn't seem to be), but the backdrop is getting cloudier.
2. It Might Not Take a Lot of Bad Macro News for Froth to Come Out of Certain Stocks at These Levels...
Though Monday's selloff could make some investors momentarily forget it, 2021 has been a year of incredible speculative excess and FOMO buying for select risk assets. From the dozens of cloud software and Internet stocks trading for well more than 20 times their forward sales, to the half-dozen pure-play electric car makers sporting $30 billion-plus valuations, to the numerous crypto tokens of dubious utility that now have $10 billion-plus diluted market caps, examples of market froth abound.
In such an environment, only a moderate amount of bad macro news might be necessary for some air to come out of the bubble, particularly with concerns about Fed tightening now also on many investors' minds.
3. ...But the Dip-Buying Mindset Probably Won't Go Away Easily
Watching the Nasdaq's tape over the last four months has been both fascinating and surreal. On many days, it has felt like there's a sea of money ready to pour into the tech sector at the first sign of weakness.
Whether due to the hubris created by a 12-year bull market, the influence of uber-bullish social media echo chambers, or a combination of the two, there's clearly a large subset of investors who are now convinced that their favorite growth stocks will only go up over time, and that even a 4% or 5% drop is cause for adding to their positions. Certainly, the tech-stock bounce seen on Monday afternoon and Tuesday morning suggests a lot of these investors simply viewed Monday's tumble as one more such buying opportunity.
It's not hard to see why such a mindset could eventually cause problems for the tech sector. If some bad news leads tech stocks to see a meaningful correction that isn't quickly ended by dip-buyers, then FOMO could turn into panic-selling, with margin calls and blown options trades adding to the misery. But for now, that sea of money can't be taken lightly.
4. Deals Can Be Found Among Tech Stocks with Little or No China Exposure
For all the froth out there, it's not too hard to find quality, moderately-priced, U.S. software and Internet companies that have little or no Chinese sales exposure. Think names such as Pinterest (PINS) , Dropbox (DBX) , Vimeo (VMEO) , Mitek Systems (MITK) (discussed recently) and Angi (ANGI) .
If markets sell off some more, then I think other software and Internet names that look a little expensive at current levels, such as Roku (ROKU) and Smartsheet (SMAR) , could also be worth a look.
5. Among Tech Stocks with China Exposure, It Might Help to Be Patient and Selective
I've been positive on a slew of chip stocks for a while. And I think some of them still don't look especially expensive, given both near-term demand trends and longer-term growth drivers. But I'll also be the first to admit that chip stocks have benefited from very positive industry news flow this year, and that markets could get jittery if a softening Chinese macro environment even moderately impacts demand within key semi end-markets such as smartphones, cars and PCs.
The same could also apply for other multinational tech companies with meaningful Chinese exposure, such as Apple (AAPL) , Tesla (TSLA) , SAP (SAP) and Autodesk (ADSK) . And certainly, Tesla and its $730 billion market cap don't have much of a margin of error right now.
This isn't meant to be an argument for avoiding all tech companies with meaningful Chinese exposure on pullbacks. But it is perhaps an argument for being patient and selective, focusing on names whose valuations provide some margin of safety and staying mindful of how much exposure a company has to Chinese consumer spending and/or real estate and construction activity.
Chip equipment stocks are one group of China-exposed companies that could have attractive risk/rewards on a pullback. Though the companies do have indirect exposure to Chinese semiconductor consumption, Beijing has given every indication that it considers domestic chip manufacturing a strategic priority. And outside of China, chip equipment makers still look poised to benefit from several growth drivers, including ongoing shortages for mature manufacturing processes, large demand and growing capital-intensity for advanced processes, and efforts by various governments to localize more chip production.
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