Information technology stocks were widely seen as dangerously overvalued a year ago, yet they are having their best year since 2009, rising 40% year-to-date as of the close on Nov. 20, 2019, versus 24% for the S&P 500. “This is where the growth is over the long term, so you’re always going to get a pretty good bid” for tech stocks, as Katie Nixon, chief investment officer (CIO) for Northern Trust Wealth Management, told The Wall Street Journal in a detailed report summarized below.

Tech stocks have outperformed recently even as value stocks have started to rebound. Moreover, the tech stocks that have posted especially big gains are a diverse group. Some examples, with their YTD gains are: FAAMG members Apple Inc. (AAPL), +67%, and Microsoft Corp. (MSFT), +47%, credit card giants Visa Inc. (V), +38%, and Mastercard Inc. (MA), +51%, as well as Applied Materials Inc. (AMAT), +82%, ASML Holding NV (ASML), +73%, and Lam Research Corp. (LRCX), +101%, all three of which manufacture the capital equipment used by semiconductor manufacturers.

Key Takeaways

  • Tech stocks are leading the market by a wide margin in 2019.
  • However, tech is among the worst sectors for Q3 2019 earnings.
  • Valuations remain high, adding to the risks.

Significance for Investors

"This is an environment where we’re finding opportunities,” says Eric Wiegand, a portfolio manager in the private wealth division of U.S. Bank. His firm has focused on software and service companies among its tech holdings.

Among the FAANG stocks, note that Facebook Inc. (FB), Netflix Inc. (NFLX), and Google parent Alphabet Inc. (GOOGL) were shifted in 2018 from the information technology sector to the new communication services sector, which is up 27% YTD. Amazon.com Inc. (AMZN) is in the consumer discretionary sector, given that retailing is its core business.

Tech stocks are soaring despite major warning signs. Of the 11 sectors in the S&P 500, information technology had weaker Q3 2019 year-over-year (YOY) earnings growth than 8 other sectors, with a 5.4% decline per FactSet Research Systems. However, this represented an improvement from the even lower expectations voiced by analysts as of June 30, when the consensus called for a 9.4% drop.

Communication services is on track to report Q3 earnings that are roughly flat YOY, while earnings for consumer discretionary are down by about 2%. For the S&P 500 as a whole, the Q3 earnings decline is trending towards 2.3%.

Another problem is that some of the biggest names in technology, broadly defined, are showing reduced momentum. Amazon.com announced its first quarterly earnings decline in more than two years, while Netflix failed for a second straight quarter to meet its goals for subscriber growth.

Among the FAANG stocks, only Apple and Alphabet, +25% YTD, have hit new highs in recent months. Amazon is a market laggard, with a 14% YTD gain, as is Netflix, +13%. Facebook, meanwhile, is up 51% despite being the focus of intense scrutiny in Washington.

Looking Ahead

Tech stocks remain pricey. The forward P/E ratio for the information technology sector is about 21 times projected earnings over the 12 months, versus a ratio of 18 times for the S&P 500 as a whole, per FactSet. Communication services is also valued at roughly at 18 times projected next 12 month earnings. Such a valuation premium for information technology implies expectations that profit growth will resume. If that does not happen in the near future, the sector may be riding for a fall.