Big tech stocks are rallying, including those among the so-called FAANG and FAAMG groups (see list below), but investors are getting increasingly nervous about the prospects for an earnings recession for tech companies, in which their profits would decline this year. Hedge funds have reduced their tech sector allocations to the lowest level since July 2016, per client data compiled by Goldman Sachs, Bloomberg reports. Meanwhile, tech-oriented ETFs have endured four consecutive months of net withdrawals, for a cumulative $8 billion outflow, Bloomberg calculates.

“There seems to be an assumption that the world economy, especially how it has affected tech, is going to be much worse” than the forecasts made by economists, as Tom Plumb, portfolio manager of the Wisconsin-based Plumb Balanced Fund (PLBBX), told Bloomberg. “A company as well managed as Apple [Inc. (AAPL)] would within a month have to significantly reduce expectations--it made people very anxious that it might just be a cliff for all these companies,” he added.

Riding High, But for How Long?

(YTD Performance Through Jan. 28, 2019)

Source: Yahoo Finance

Significance for Investors

The gloomy outlook for tech is growing despite expectations that the S&P 500 Index as a whole will enjoy higher earnings in 2019, though with a smaller year-over-year (YOY) growth rate than that seen in 2018. It also runs contrary to analyses that cite tech as likely to enjoy secular growth regardless of general economic ups and downs.

The current earnings reporting season is expected to show tech sector earnings growing at a slower pace than for the entire S&P 500, and for the second straight quarter, Bloomberg notes. Worse yet, the report adds, the consensus among analysts is that tech will suffer YOY earnings declines in the first two quarters of 2019, and perhaps later on as well.

Today's skepticism about tech represents a significant reversal from the situation in 2018, when there was widespread concern about overcrowded investments in the sector, especially in a few of the most popular names such as the FAANG and FAAMG stocks. Indeed, investors have been rotating out of tech and into defensive stocks for several months.

More recently, investors have been building up their cash balances at the fastest pace since the financial crisis of 2008, The Wall Street Journal reports. At the same time, while they remain generally bullish about the economy and stocks in 2019, Goldman Sachs recommends that investors reduce risk by building up their cash reserves even further.

Meanwhile, tech is notably absent from the sectors that are expected to lead the market going forward, per a report from Morgan Stanley. Tech also is not among the sectors that are most compelling on the basis of valuations, per Bank of America Merrill Lynch. By contrast, tech still offers "strong idiosyncratic growth and limited dependence on the path of economic activity," according to another Goldman Sachs report.

Looking Ahead

It may be premature to conclude that the glory days for big tech stocks are over, but is apparent that investors have become much more cautious about the sector. It remains to be seen whether his suggests that bargains now exist in tech stocks, or whether a longer-term decline is underway.