Tech Selloff Creates an Opportunity

Summary

In this article, Russ Koesterich explains how the recent market rotation has pressured tech stocks while creating an attractive long-term buying opportunity.

Key Takeaways

• After a powerful rally earlier in the year, technology and semiconductor stocks experienced one of the sharpest corrections in recent memory, with the sell-off reflecting a broader market rotation out of momentum winners and into previously lagging sectors, such as financials and healthcare.
• While technology stock prices have fallen sharply, earnings expectations continue to improve: Tech has seen the strongest positive revisions, with projected earnings and sales growth significantly exceeding that of the broader market.
• This correction, however, has created a potentially attractive long-term buying opportunity for investors, as the combination of falling stock prices and rising earnings compressing valuations – making tech appear relatively inexpensive compared to its history.

When most investors think of seasonal trends in the stock market, they tend to think of old adages, such as ‘sell in May and go away’. While summer and early fall weakness has worked reasonably well as a long-term trading strategy, these past few years a different seasonal dynamic has dominated: A violent rotation out of previous winners.

This year, the rotation has hit the dominant momentum trade, inflicting pain on technology leadership, with AI-related names getting singled out for the harshest punishment. The rotation out of tech, and semiconductor companies in particular, has been one of the more violent in recent memory, but it has also created attractive long-term value. While these rotations often last into the early fall, for long-term investors it’s worth starting to focus on opportunities in the tech space.

From First to Last

This year tech returns have been strong but volatile. The sector fell along with the broader market in March, but since then returns have been spectacular. Between the announcement of the cease-fire with Iran and the peak in early June, large cap technology companies measured by the Nasdaq 100 Index advanced more than 40%, semiconductor stocks measured by the Philadelphia Semiconductor index were up by roughly 60%, and memory chip companies, the epicenter of the AI arms race measured by the Bloomberg Memory Index, up approximately 150%.

However, during the past month prices have abruptly reversed. Globally technology has been the worst performing sector on a one-month basis (see Chart 1), with momentum driven semiconductor companies entering a bear market. The Philadelphia Semiconductor Index (SOX) fell 20% in less than a month, it’s fastest correction since the tech bubble burst in 2000. The beneficiaries of this selling have been previous market laggards, particularly financial and healthcare stocks.

Chart 1
Global sector performance - 1 month

A value play?

While it is hard to think of a previously surging momentum trade as cheap, that is what has happened. Even as prices have collapsed, earnings continue to surge. On a one-month basis, the U.S. technology sector has seen the most aggressive positive revisions to earnings. In data from LSEG Datastream, MSCI and BlackRock Investment Institute, estimates for forward 12-month earnings and sales are 40% and 25% respectively, with expected earnings growth more than double the broader market.

The combination of falling prices and surging earnings has led to a significant re-rating of the sector. Currently, the tech sector evidenced by the MSCI World Information Technology Index is trading at roughly 21x forward earnings according to Bloomberg, well below the 10-year average. Relative to the market, the P/E is the lowest since last year’s ‘Liberation Day’ sell-off and well-below the average of the past five years.

At the same time, we are starting to witness an adjustment in investor positioning. One example is the reduction in levered ETF’s tied to technology and semiconductor companies, a trend which helped to drive the spring rally. While lingering seasonals may prevent an immediate bottom, longer-term tech is becoming the rarest of things: Cheap.

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