Why are Tech Stocks Getting Hit So Hard?
As the Russian invasion and spiraling oil prices continue to roil markets, one category of stocks in particular has taken an outsized beating – technology. With the selling pressure in the first week of March, the tech-heavy Nasdaq officially slid into bear market territory, declining more than -20% from the highs reached in November 2021.1
To be fair, the current selloff is affecting a broad swath of stocks. But why are technology stocks getting pummeled harder than other categories?
The first part of the answer goes all the way back to 2020, the year the pandemic took hold and fundamentally altered the way many businesses and workers interacted with the economy. When the global economy shut down in the spring of 2020, it became apparent quickly that many businesses would either need to shut down operations or move them online. The uniqueness of the economic downturn—which required people to stay home—actually boded well for technology companies that could facilitate this new reality.
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The demand for Zoom conference calls, Amazon orders, software and cloud services, and other digital infrastructure created a major tailwind for technology companies operating in the space. The swell of earnings and expected earnings from the transition to remote work and ‘digital everything’ arguably led to the S&P Technology sector’s wide outperformance in 2020, which saw it deliver a +43.9% jump. As the pandemic continued to weigh on public health and the economy in 2021, technology continued to outperform – rising +34.5% for the year, second only to Real Estate’s +46.2% increase.3
The big increases for technology in this period, and in previous periods, has not been unjustified, in our view. The sector’s outperformance has been driven by consistently higher forward earnings as compared to the rest of the S&P 500. Apart from a short period in 2013, S&P 500 Information Technology has been the U.S. economy’s best earnings generator, so it makes sense that it would also be its best sector performer. As a result, technology stocks were bid higher, with many trading at valuations many times higher than stocks outside of the sector. With interest rates stuck at close to zero for the previous two years, investors felt comfortable paying a high premium for the fast growth technology companies promised.
That all changed late last year, however, when inflation became a problem. When minutes from the Fed’s December 14-15 meeting were realeased in early January, market participants learned interest rates were going to move up higher and faster than previously expected. Stocks sold off sharply on the news, with the Nasdaq posting its worst single-day loss since February 2021.
Interestingly enough, the Nasdaq’s peak came in mid-November, which coincided very closely with the Federal Reserve’s ‘pivot’ to tighter monetary policy and the likelihood of higher interest rates.
Questions started to swirl about the impact rising interest rates would have on stocks. Consensus seemed to be that rising rates are problematic – they would result in multiple compression over time, and in the short-term would deal a major blow to high valuation stocks, like high-flying ‘growthy’ tech names. During the current correction, we can see the outsized selling pressure on technology stocks taking hold.
In our view, the outlook for the technology sector is one where rising rates will challenge high valuations, and may make outperformance for the sector more challenging going forward. But long-term investors should stick with the sector, however, as secular trends in the economy argue for a favorable view. One of the key drivers, for example, will be the future of “hybrid work,” which involves splitting time between the office and working from home. Many major corporations have embraced this ‘new normal,’ and others may have to if they want access to top skilled talent in the labor pool.
In the short-term, technology companies face challenging earnings comparisons from 2021, while also dealing with the impact that rising rates could have on multiple compression. But then again, the current sharp sell-off in the technology sector may be the market pricing-in these challenges now, which could also be setting the table for a “v-shaped” recovery we typically see after market corrections.
Bottom Line for Investors
The broad market sell-off has been hard on technology stocks, which should not come as much of a surprise to market-watchers. Technology stocks have strongly outperformed for the past few years, and as such, the sector holds a high proportion of high valuation names. The market sell-off has disproportionately targeted the ‘expensive’ categories of stocks.
Interest rate increases throughout the year could add pressure, but in our view, it is also true that the market has largely discounted the Fed’s planned rate increases. Moving interest rates higher at Fed meetings no longer has much surprise power for markets. In our view, once the uncertainty of the geopolitical conflict and oil prices fades, technology stocks could benefit most from the market rally on the other side of the correction. Now is a time to stay patient.
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At Zacks Advantage, we strive to help every investor properly allocate their assets. In fact, we’ve put together a helpful guide to help you understand the basics of portfolio diversification, including:
- 4 myths of a properly diversified portfolio
- Why the average investor’s returns trail almost every other investment category
- How to create a truly well-diversified portfolio
Get our free guide, Is Your Investment Portfolio Actually Well-Diversified?,4to learn how to create a truly diversified portfolio.
2,4 Zacks Investment Management may amend or rescind the Revolutionize Your Retirement guide offer for any reason and at Zacks Investment Management’s discretion.
3 Strategas 2022
Past performance is no guarantee of future results. Inherent in any investment is the potential for loss
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