A surge in market volatility this year, driven by factors such as fears over tightening monetary policy, rising global trade tensions and more government regulation has weighed on some of the highest-flying tech stocks that have driven gains in recent years.
As some see the weakness, led by social media giant Facebook Inc. (FB), as presenting an opportunity to buy on the dip, others recommend getting out before lawmakers buckle down on Mark Zuckerberg's social networking behemoth and its tech and media peers, who face reclassification under the new "communications services" sector. Meanwhile, a crackdown on big tech may make other tech companies that remain outside of the regulatory burden more attractive.
Reclassification to Benefit Legacy IT
Goldman Sachs chief U.S. equity strategist David Kostin issued a note in response to Zuckerberg's congressional hearings last week, which Kostin wrote "raised investor concerns about the potential for government regulation and the use of consumer data." He also sees risk for Facebook and similar companies as they are reclassified by major indexes like the S&P and MSCI families. Facebook's media peers including the Walt Disney Co. (DIS), Google parent company Alphabet Inc. (GOOGL) and Netflix Inc. (NFLX) are among those likely to move from information technology to communications services, a new sector set to take the place of telecommunications services. (See also: Why These 4 Big Tech Stocks Are Bargains.)
Kostin indicates that the new environment could present a great buy opportunity for legacy tech companies that remain in the IT sector after big media names are cut out.
"The future 'legacy' Tech (i.e., firms remaining in the sector) will have much slower expected sales and earnings growth and lower margins than both the current Tech sector and the new Communication Services sector. However, the 'legacy' Tech sector trades at a lower valuation," wrote the Goldman analyst. These companies, which are highly correlated to Facebook, have underperformed the tech sector and the broader market, noted Kostin, citing the increasing use of exchange-traded funds as a reason for the stocks' weakness, since they are including alongside Facebook and this suffer from its decline.
Stocks that stand to gain from Facebook and its peers' new classification include Cisco Systems Inc. (CSCO), NVIDIA Corp. (NVDA) and Global Payments Inc. (GPN), as well as Broadcom Ltd. (AVGO), Micron Technology Inc. (MU) and Lam Research Corp. (LRCX), according to the Goldman strategist. (See also: 'Occupy Silicon Valley' Trend Could Hurt Tech Stocks.)