Why Tech Stocks Rising at Fastest Pace in 7 Years May Flame Out

Technology stocks are soaring at their fastest pace in more than 7 years, with Microsoft Corp. (MSFT), Apple Inc. (AAPL), Amazon.com Inc. (AMZN), Facebook Inc. (FB) and Alphabet Inc. (GOOGL) collectively adding about $330 billion in market value over the past five trading sessions, according to the Wall Street Journal. But some market watchers suggest the optimism may be overdone, leaving tech stocks at risk of a steep pullback in light of historical trends, weak earnings forecasts, and antitrust probes.

Why To Be Skeptical of Tech’s Rally

  • Techs drastically underperform in year after Fed rate cut
  • Tech earnings forecast to fall in 2019
  • Amazon, Apple, Alphabet, and Facebook face antitrust probes

Source: Goldman Sachs, Investopedia

What it Means for Investors

Investors have become increasingly confident that the Federal Reserve will cut interest rates before the year is out -- as key economic indicators have weakened and as Fed Chair Jerome Powell has turned even more dovish. But while rate cuts and the start of a new rate-cutting cycle historically have been beneficial to stocks, the tech sector may be another matter.

In fact, tech stocks have drastically underperformed the broader market in the year following the start of a new rate-cutting cycle, according to Goldman Sachs. The firm analyzed 7 rate cutting cycles during the past 35 years, focusing on stock performance after the first interest rate cut. The bank found that, while the S&P 500 climbed by a median 14% over the subsequent 12 months, the tech sector lagged the S&P by 13 percentage points, making it the worst performing sector in the index.

Goldman’s report also outlined consensus estimates that cast doubt on optimism about strengthening tech fundamentals, at least in the short term. The tech sector’s earnings-per-share (EPS) growth is expected to be negative in three out four quarters in 2019, and earnings are expected to decline by 3% for the year as a whole, according to consensus bottom-up forecasts. Tech sector sales-per-share (SPS) growth is expected to be among the worst in 2019, at just 3%. Goldman's own forecasts are stronger but nonetheless reflect less than robust growth.

To be sure, tech earnings in 2020 look a bit brighter. Consensus forecasts expect SPS and EPS growth to be 7% and 14%, respectively. Yet, those estimates fly in the face of Morgan Stanley’s recent downward revision of U.S. corporate earnings forecasts in 2020, expecting growth to be the same as in 2019. If Morgan Stanley’s forecasts are right, it will mean zero profit growth for two consecutive years for the S&P 500, according to Bloomberg.

Further negative news is likely to weigh on the sector as U.S. regulators begin investigating the dominant market positions of tech’s biggest players, including Apple, Alphabet, Amazon and Facebook.

Looking Ahead

Of course, the market's mood could change markedly if the U.S. and China resolve their trade conflict. A smooth resolution would not only be a boon for tech, but the entire global economy. As for the antitrust investigations, some experts argue that a break-up of big tech would actually add value to the sector, and boost stocks and profits for investors. What is certain is that the myriad of headwinds facing tech stocks ensure that they face wild swings ahead.

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