For some parts of the tech sector, the market's current mood still feels a little like 2000. For other parts, however, it feels a similar to late 2018.
In late 2018, equities tumbled -- with many tech stocks reaching valuations that look dirt-cheap relative to where they stand today -- on worries about a tightening Fed, trade tensions with China and a peaking semiconductor cycle. At its late-December low, the Nasdaq came close to touching 6,000.
Needless to say, those investors who braved the waters and bought quality tech companies in December 2018 made out pretty well. The Fed backtracked on its tightening plans and trade war fears proved overblown. And while the semi cycle did peak, the industry's 2019 downturn proved milder than what many feared, which in turn helped the Philadelphia Semiconductor Index rise over 50% that year.
Today, we're seeing many inexpensive stocks that are seen as cyclical plays, reopening plays or otherwise sensitive to near-term macro conditions sell off amid fear that a spike in Delta-variant COVID cases will lead to a fresh round of major lockdowns. And Treasury yields are plummeting, as markets both fret about the Delta variant's macro impact and continue believing that any inflation pressures are transitory.
All of this feels pretty late 2018-like to me. For starters, while there's no denying that the Delta variant is driving a spike in COVID cases in many regions, I think fears that we're about to see a repeat of what happened in March 2020 (or anything close to it) are quite overblown. Among the reasons why:
- While vaccinated individuals are at somewhat greater risk of being infected with the Delta variant than they are with older COVID variants, all evidence indicates the risk of a vaccinated person becoming seriously ill from Delta remains very low. A recent U.K. study found that the Pfizer (PFE) and AstraZeneca (AZN) vaccines are respectively 96% and 92% effective against hospitalization when dealing with Delta -- roughly matching their effectiveness against the Alpha variant.
- Vaccination rates are now quite high among the elderly in the U.S. and many other developed nations. Roughly 75% of U.S. adults aged 65 and older have now been fully vaccinated.
- The global rollout of COVID vaccines has inflected over the last several weeks. In terms of vaccine doses administered per 100 people, Western Europe and China are now roughly on par with the U.S., and Canada is ahead. In two or three months, vaccines should be easily available to a pretty large percentage of the world's population.
- Though they're more vulnerable to Delta than the vaccinated, polls have shown that unvaccinated Americans are on average less concerned about Delta than vaccinated Americans. This, along with the fact that vaccines have now been widely available to U.S. adults for months, makes the political case for imposing widespread lockdowns to protect the unvaccinated quite tenuous.
- Between vaccination rates and the percentage of people (vaccinated or not) who have already been infected with COVID, we might be closing in on herd immunity, or at least a point where COVID case growth is limited by a significantly reduced number of potential spreaders.
Meanwhile, there are still plenty of reasons to think that the rebound that has been taking place in discretionary consumer spending in recent months still has a ways to go. Travel, hospitality and discretionary retail spending hadn't reached their pre-COVID trend lines even before recent Delta variant fears; consumer savings rates have been elevated for more than 15 months; wages are rising; interest rates remain quite low; and high equity and home prices are creating wealth effects.
Inflation, rather than deflation and a major economic slowdown, still looks like the biggest risk to me looking six to 12 months down the road -- even if prices cool off some for cars, game consoles and other supply-constrained items as supply-chain bottlenecks are addressed.
But right now, equity and bond markets are acting as if the inverse is true -- driving Treasury yields to rock-bottom levels; selling off commodities, cyclicals and reopening plays; and bidding up lockdown beneficiaries and many other high-multiple growth stocks that are especially vulnerable in an inflationary environment.
It's worth noting that a lot of high-multiple growth stocks would look pretty expensive even if inflation proves fully transitory and the 10-year Treasury yield somehow stays around 1.2%. Right now, there are more than 30 tech companies with $10 billion-plus market caps that have forward EV/sales ratios above 20. By any standard, valuations are quite stretched for numerous growth software, Internet and EV/clean energy names.
Against this backdrop, I think there's a good argument for selectively buying reopening plays and commodity/cyclical names that have been hammered over the last couple of weeks. Within tech, chip equipment makers such as Applied Materials (AMAT) , KLA (KLAC) and Axcelis Technologies (ACLS) look compelling to me, given moderate valuations and the fact that chip equipment spend looks poised to remain healthy beyond 2022, even if one assumes the current semi cycle peaks at some point next year. I think the risk/reward also looks good for beaten-up reopening plays such as Eventbrite (EB) and Lyft (LYFT) .
Separately, I think there's a case for hedging by shorting some high-multiple and speculative names, particularly since borrow rates for many shorts have dropped considerably since May (over the last week, I've opened up shorts in names such as Carvana (CVNA) , Xpeng (XPEV) and SoFi Technologies (SOFI) ). And though it's possible that yields drop further before bottoming in a fear-driven environment like the current one, Treasury shorts might also be worth a look.
In a lot of ways, this market environment -- one in which many equity and bond investors seem intent on pursuing the same trades that have worked over the last few years, regardless of how extreme valuation differences have become and how much money the Fed has printed -- is screaming for a mean-reversion.
Such a mean-reversion might not happen right away. But based on what's known about the Delta variant, vaccine rollouts and macro conditions, I think betting on it makes a lot more sense than betting on the status-quo to continue.