For the bear market in tech stocks to end, we'll probably need some true capitulation in the frothiest corners of the sector.
Also, we might need tech-stock rallies to stop having so much in common with traditional bear-market relief rallies.
What Tech Rallies Have Looked Like Lately
The giant tech rally seen on Thursday -- after markets opened sharply lower on news of Russia's invasion of Ukraine -- fits with a pattern for relief rallies that has been in place since the one seen following the Fed's mid-December meeting. These rallies, some of which have followed anticipated news events, have generally sported a few common traits:
- The biggest gainers have skewed heavily towards the still-expensive bull-market favorites of retail and institutional growth/momentum investors. Think cloud software names such as Asana (ASAN) and Atlassian (TEAM) , or high-beta Internet stocks such as The Trade Desk (TTD) and Global-e Online (GLBE) , or electric car and clean energy plays such as Rivian (RIVN) and Plug Power (PLUG) (admittedly, some beaten-up growth stocks that have arguably fallen to reasonable valuations have also rallied strongly).
- There have been major short-covering rallies/squeezes in stocks with high short interests. This group includes some of the aforementioned companies, as well as SPACs, meme stocks and other speculative plays.
- Low-multiple tech stocks have often underperformed -- and not just low-growth, old-guard, tech companies such as IBM (IBM) and HP Inc. (HPQ) , but also a lot of profitable and moderately priced software, Internet and chip stocks that look quite capable of posting double-digit annual earnings growth over the next few years.
In other words, the very tech stocks that are the most vulnerable to being hurt by the monetary-policy regime change initiated by the Fed in late 2021, and which have often fallen sharply on down days over the last three months, have typically been the stocks catching the strongest bids when tech stocks have strongly outperformed. And both inside and outside of tech, a lot of the stocks that one would expect to do relatively well in an environment featuring high inflation, rising yields and a tightening Fed have lagged.
Days like this might feel familiar to veterans of the Dot-com bubble's collapse. Though I don't think the medium-term outlook for the broader tech sector is as bleak now as it was then, there are similarities between the sharp relief rallies we've seen since December and the big rallies that occasionally happened as the Dot-com bubble deflated in late 2000 and early 2001. In addition, there were also a few rallies like this during the market's 2008/2009 crash.
(Friday's action, in which the Nasdaq gained 1.6% but trailed the S&P 500's 2.2% rise, was definitely a little different, with high-multiple growth stocks underperforming on the whole. But at the same time, these companies typically held onto most or all of their big Thursday gains, and added to them in some cases.)
Combine all of this with how high valuations remain for certain growth stocks, as well as the speculative excesses that remain for non-equity assets such as cryptos and NFTs, and there's ample reason to think Thursday's action won't mark a bottom. Rather, it might prove to be the latest in a string of rearguard actions -- fueled in part by short-covering, and also in part by dip-buyers who refuse to accept that the easy money-fueled asset-inflation of the last two years is over -- that merely delays the final washout needed in high-multiple and speculative risk assets for the tech sector to put in a bottom.
This is a shame, because there are deals to be found within the tech sector right now, in spite of the froth that remains here and there. And in a highly correlated market that's become dominated to a large extent by passive fund flows, quants/algos and retail and institutional investors prone to buying/selling cheap and expensive stocks in tandem, the cheaper stocks remain prone to getting hit alongside their frothier peers, albeit by a smaller degree on average.
What a Strong Economy and High Inflation Could Spell for Tech Stocks
The macro environment still looks decent on the whole. Though a subset of investors who want the Fed's easy-money regime to continue are still clamoring that Jerome Powell & Co. are poised to trigger a deflationary recession by tightening, January and February's major earnings reports -- from big banks, big retailers, tech giants and many others -- suggest consumer spending remains healthy, albeit with some shift from goods to services spending.
Macro data such as this month's retail sales and PCE reports also suggest consumers remain eager to spend, in spite of growing unease about inflation. And businesses, which generally remain flush with cash and able to obtain (by historical standards) low borrowing rates, are still hiring and investing aggressively.
The environment also looks decent on the whole for the tech sector. While one needs to stay mindful of how reopening activity is pressuring e-commerce spending (particularly for discretionary goods purchases) and home electronics sales, demand for cars, high-end smartphones, corporate PCs, gaming hardware, data center hardware, chip equipment and cloud software and services still looks pretty good.
At the same time, inflation clearly isn't letting up, as this month's CPI, PPI and PCE reports drive home. And though transitory-inflation die-hards will disagree, I think the pandemic's end might do more to increase inflation than decrease it, as the deflationary effects of easing supply-chain pressures and higher labor-force participation are offset by higher services, labor and energy demand and the increased demand for some parts/materials that comes from things like greater auto production and housing starts.
An environment in which inflation keeps running hot and the monetary policy remains hawkish, but in which consumer and corporate spending is still registering decent growth (i.e., the kind of environment that many emerging-market economies have dealt with), is one in which some tech stocks could still do well, even if investors will probably need to be more valuation-sensitive than was necessary for much of 2020/2021.
Moderately priced chip developers and equipment makers -- a group of companies that are typically seeing demand outstrip supply and have been flexing some pricing power -- could fare well in such an environment. So might be beaten-up Internet and fintech companies whose business models involve taking a cut on transactions (and thus see their sales go up as average transaction prices rise). And of course, reopening beneficiaries such as Booking (BKNG) , Expedia (EXPE) , Uber (UBER) and Lyft (LYFT) (many of which also have inflation-resistant business models) could outperform.
But in the short-term, there could be more pain ahead for the tech sector at-large, if (as is quite possible) the reckoning that's been happening for high-multiple and speculative risk assets isn't over yet. As a result, this is probably a good time for tech investors to remain hedged.