Are technology stocks set to turn higher?

You used to be able to tell a true growth stock from the rest. Screening for companies growing their earnings at a rapid and consistent pace over five years or more was once a good place to start. In general, that growth came at a price. Investors were willing to stump up for such consistency, sometimes paying vast multiples of earnings to secure a stake in a company’s future.

Today the line between growth and value has become more blurred. Former growth stalwarts in the technology sector have seen their growth rates coming under pressure, either as the tailwinds (for them) of the Covid-19 pandemic, slick global supply chains or ever increasing advertising opportunities have blown themselves out.

Markets have responded without mercy. Share prices have fallen even as earnings have continued to increase. Two of America’s fast growing “FAANG” stocks – Meta and Netflix – along with PayPal – were officially reclassified as value stocks in the US this summer¹.

The logic of attaching a lower value to companies whose average future earnings are weighted far out into the future has become difficult to resist as interest rates have risen, especially when there are businesses in the energy and mining sectors enjoying the considerable fruits of their labours very much in the present day.

The downgrading has been as severe as any we have seen since the dotcom bust at the turn of the century. The Bloomberg World Technology Index now trades on 21 times historic earnings, only a little more than the 18 times earnings of America’s broad-based S&P 500 Index².

Investors, it would seem, are no longer willing to pay much of a premium at all for access to the technologies that will undoubtedly help shape the world over the decades to come.

That begs the question, is now the right time to act on the opportunity?

A step back into the latest results season brings the dilemma now facing investors into sharp relief. Apple may have drawn a sharp intake of breath from investors with its record US$90 billion in sales last quarter, up 8% on the same period in 2021³. However, other leading technology companies have provided us with plenty to fret about, despite their vast revenues and profits.

Amazon was downbeat on its sales forecasts. It announced cost saving measures too, including a freeze on staff hiring, even as we head towards the busiest retail time of year. Google’s parent Alphabet reported a downturn in online advertising had hit its YouTube business, while Microsoft said a strong dollar and softer personal computer (PC) sales had weighed on its profits.

There was an element of despondency at Meta too, which warned of a challenging outlook owing to new pressures on advertising revenues and the rising competition for Facebook from newer rivals like TikTok.

Apple’s recent privacy changes for the iPhone have constricted the information advertisers will receive back about their customers, reducing the appeal of campaigns. Workarounds using data modelling and machine learning may plug the gap but, as yet, we don’t know how effective these will be.

On top of that, the US Federal Reserve Bank (Fed) raised interest rates again this week and signalled it was bracing to raise rates further still⁴. News of that put shares into a mini tailspin on Wednesday, although conditions have since stabilised.
Even if most of the long term plans of technology companies play out in reality, the road ahead is unlikely to be billiard-table smooth.

Matters improved for tech stocks as the share prices of the market leaders bounded like the proverbial coiled spring the second half of last month. This, in itself, is a positive. The catalyst for the bounce-back was supposedly no more than a hint in markets that the Fed might be about to become a little less hawkish on interest rates, given signs of cracks finally beginning to appear in the high inflation story.

You could interpret this as a sign that investors are more than ready to return to the sector at the first sign of light on the horizon. And why wouldn’t they be? In a world of uncertainty and rapid change, it makes sense to back the proven winners with adaptability and innovation on their side. Short term market setbacks may provide the best opportunities to do just that.

For some investors, calling the precise turning points for markets is more of an art than science, and can’t realistically be part of a long-term strategy. Empirically, investors will already know that the best rewards come through investing when it’s hardest to do so, at times of great uncertainty and doubt.

The simplest way to ensure investments are accumulated at the moments when it hardest to click the buy button is through a regular savings strategy that removes the need to time purchases. A regular savings plan means shares or fund units automatically get bought the same day each month – more if markets are weak; fewer if markets are looking like a one-way bet (after a rise).

The unreliability of our shared investing psychologies underlines the futility of calling a bottom for technology stocks – which may or may not have occurred last month. What we do know is that the sector looks inexpensive compared both to its own history and the rest of the stock market, suggesting we are probably at a good point in time to be accumulating investment tranches on a regular basis.

Originally published by Fidelity International investment experts