Technology stocks have delivered market-beating performance for a decade, but the end is near for their extended period of dominance, according to analysis by RBC Capital Markets, as cited by Barron's. Lori Calvasina, head U.S. equity strategist at RBC, has been bearish on the technology sector since April, and recently reiterated her underweight rating for it, unmoved by the market's strong positive response to an upbeat earnings release from FAANG and FAAMG member Apple Inc. (AAPL). The six red flags that she raises about tech stocks are listed below.
|Index||10-Year Gain||1-Year Gain|
|Nasdaq 100 Index (NDX)||288%||26%|
|S&P 500 Information Technology Index||257%||30%|
|S&P 500 Index (SPX)||120%||15%|
Sources: S&P Dow Jones Indices, Yahoo Finance
Bolstering Calvasina's case is the fact that tech stocks are a major driver of rampant overvaluation in the U.S. stock market as a whole, given that the tech sector represents 26% of the value of the S&P 500, per Fidelity Investments, and 56% of the Nasdaq 100, per Nasdaq.com. Doug Ramsey, chief investment officer (CIO) at The Leuthold Group, sees disturbing parallels between the overvalued dotcom bubble market of 2000 and today's market, MarketWatch reports. Worse yet, he writes, as quoted by MarketWatch, "Overvaluation in 2000 was highly concentrated, today it is pervasive." He adds, "the wonderment surrounding the disruptive technology of today's market leaders seems to have swelled to maybe 1998-ish levels." (For more, see also: 3 Tech Stocks Nearing a Breakout.)
Tech Stocks: 6 Red Flags
|Deteriorating Positive Sentiment on Tech Stocks|
|Valuations at Post-Bubble Peaks|
|Declining Tech ETF Inflows|
|Decelerating Earnings Growth|
|Rising Dollar Reduces Tech Exports and Dollar Value of Overseas Earnings|
|High Risk of Profit Taking in Tech Stocks|
Each red flag is discussed in more detail below.
Calvasina notes that buy ratings on tech stocks from sell-side analysts are at post-bubble highs, and starting to decline in number. Moreover, she indicates that institutional investors are looking to trim their holdings of big tech stocks, most notably the FAANG group, which includes Facebook Inc. (FB), Amazon.com Inc. (AMZN), Apple, Netflix Inc. (NFLX) and Google parent Alphabet Inc. (GOOGL). While she is among those who believe that investments in tech stocks are extremely crowded, Goldman Sachs disagrees, and they have issued a positive outlook for the sector. (For more, see also: Tech Stocks Will Get Big Boost From Buybacks: Goldman.)
In terms of both price-earnings (P/E) ratios and enterprise value to EBITDA (EV/EBITDA) ratios, Calvasina finds that tech sector valuations are at post-bubble peaks. Additionally, she calculated that, as of the Monday July 30 close and before Apple reported earnings, the tech sector P/E was 1.18 standard deviations above its historical average.
Declining ETF Inflows
A major source of demand for tech company shares, buoying their prices, has been buying by ETFs, including tech-oriented ETFs. She indicates that net purchases by ETFs appear to have peaked in the first quarter, and have headed downward since then.
Decelerating Earnings Growth
Reported earnings per share (EPS) by tech companies had been beating analysts' estimates consistently, driving frequent upward revisions to these forecasts. Now she sees the pace of both "starting to decelerate for the sector off peak levels," as quoted by Barron's.
The Rising Dollar
Given that the U.S. tech sector has high international exposure, both through exports and the earnings of overseas divisions, Calvasina observes that a continued increase in the valuation of the U.S. will provide a headwind for revenues and earnings. A rising dollar increases the cost of exports in terms of local currencies, while it also reduces the U.S. dollar value of sales and earnings generated abroad.
After enjoying strong gains from their holdings of tech stocks, actively-managed growth funds may be tempted to lock in some of those profits. This is especially likely among funds that are overweight in technology. If such selling becomes widespread, it inevitably will exert on tech stock prices.