A Mixed Near-Term Outlook for Tech Stocks

The broad US and global stock markets have been under pressure in 2022, but technology stocks specifically have fared even worse. Year-to-date through September 30th, the S&P 500 has fallen -23.9%, which seems steep until you consider Technology’s -31.4% decline and Communication Services’ (which includes many key technology names) -39% drop over the same period.

The problem for many would-be tech bargain hunters is that some of the biggest names in tech still appear overvalued relative to the broad market, even when factoring in the selloff. According to DataTrek Research, Google, Amazon, Tesla, Meta, Apple, and Nvidia trade at 38x forward earnings on average, more than double the 16.7x multiple for the S&P 500. It seems that the selling pressure has pulled some technology names from “very overvalued” to just, “overvalued.”¹

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There are many headwinds to technology companies and growth stocks in general, but perhaps the biggest force in 2022 has been rising interest rates. When yields in the bond market rise, it makes the future cash flows of corporations less valuable, since investors have options when it comes to earning a return. When interest rates are near zero, investors are willing to pay a premium for the possibility of rapid growth. When interest rates are at current levels, however, that appetite for risk decreases. With bond yields experiencing one of the sharpest increases in 2022 that investors have seen in decades, many are pulling away from high-valuation technology companies with particular intensity.

Earnings have not been helping the outlook. For the S&P 500’s Information Technology and Communications Services sectors, earnings have fallen 9% and 13%, respectively, since August. Earnings projections have been coming down across many sectors in the S&P 500, but much like year-to-date performance, technology has been close to leading the way down.

Taken together, these economic trends and data paint a fairly bleak picture of the technology sector. But that doesn’t necessarily translate to turning bearish on the sector. In fact, the opposite could be true, given the magnitude of losses that have already been booked in 2022. Stocks tend to bottom during recessions and about 6-12 months before a trough in earnings, which by some estimates, could mean very soon.

Stocks also tend to perform well once inflation peaks and economic growth goes from being very weak to improving, conditions Zacks believes could surface in early 2023. Weak growth into 2023 could also raise the possibility that the Federal Reserve eventually pauses interest rate increases or even lowers them, which could lead to a repeat of 2019 when growth stocks outperformed value as the Fed shifts from raising rates to cutting them.

Another factor worth considering is the US midterm election. Stocks tend to do well in the year following a midterm election, historically. Since 1950, there have been 18 midterm elections, and stocks have gone up the following year 100% of the time. And not only do stocks go up, they tend to go up by a lot. From 1950 to 2018, here are the forward returns for the S&P 500 following a midterm election:

• 6 Month Forward Return = +35.5%
• 12 Month Forward Return = +18.6%
• 24 Month Forward Return = +15.2%

The reason this positive performance may matter for tech is that in the year following 10 of the last 12 midterms, technology has been the best-performing sector in the S&P 500. Technology has also outperformed the broad S&P 500 in year 4 of a presidential election cycle historically, which gives another boost to the medium-term outlook for stocks in the space.

Bottom Line for Investors

The current environment of rising interest rates and slowing economic growth paints a mixed picture for technology stocks. On the one hand, rising interest rates reduce the value of future cash flows for stocks in the space, and earnings in the sector have been coming down. On the other hand, stocks tend to bounce during recessions and about 6-12 months before earnings hit a bottom, which could arguably be sooner than most expect.

Longer-term, the outlook for technology is less mixed. Companies in the sector thrive on innovation, and innovation is showing no signs of stopping any time soon. Many would argue that the runway for new technologies like enterprise cloud, software-as-a-service, artificial intelligence, and e-commerce is broad and long, with today’s challenges only stepping-up competition to innovate faster and more efficiently. When viewed through that prism, a mixed near-term outlook is less meaningful to investors than a strong medium- to long-term outlook.

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¹ Wall Street Journal. September 10, 2022.

² Zacks Investment Management may amend or rescind the Revolutionize Your Retirement guide offer for any reason and at Zacks Investment Management’s discretion.

³ Zacks Investment Management may amend or rescind the Revolutionize Your Retirement guide offer for any reason and at Zacks Investment Management’s discretion.

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