America's top tech companies have come under intense pressure following a series of disappointing earnings announcements, including from Meta, Alphabet, Amazon, and Microsoft. But while tech stocks have already fallen a long way, underperforming the broader market, we see further weakness ahead as businesses and consumers trim spending. While valuations have declined, the sector still does not present good value, in our view.
The tech sector has underperformed the market, amid weaker third-quarter earnings.
- Shares in Alphabet, Microsoft, Amazon, and Meta Platforms all fell sharply following their earnings announcements last week.
- Apple's results were the exception, with shares rising on record revenues, with premium iPhone sales showing some resilience.
- However, the tech sector has continued to lag the broader market in 2022, with the Nasdaq down 29% year-to-date, versus 18% for the S&P 500.
But despite the decline, we do not believe the sector is fully priced for the challenges ahead.
- Ebbing business confidence looks likely to erode capital spending on technology. Advertising spending is also weakening.
- The US IT sector is heavily exposed to overseas markets and hence vulnerable to the stronger US dollar.
- Valuations have declined but are not necessarily “cheap,” as the US IT sector still trades at a 21% premium to the broader market.
So we remain least preferred on the tech sector and prefer more defensive parts of the market.
- Consensus estimates for IT sector 2023 earnings have fallen 8%from their peak, and we expect further estimate cuts to come.
- We remain cautious on cyclical tech industries such as semiconductors, hardware, and digital media.
- Instead, we recommend tilting exposure to more defensive sectors, including healthcare and consumer staples, which are less vulnerable to slowing growth.
Did you know?
- After more than a decade of expanding valuation, the IT sector’s price-to-earnings ratio has declined by 34% from 29 times to 19 times, compared with a decline of 26%for the S&P 500.
- The IT sector is the most global of all S&P 500 sectors, with more than 58% of revenue coming from outside the US compared with 40% for the S&P 500.
- Meta Platforms, Facebook’s parent, fell 24.5% on 27 October after it reported falling revenue and weaker forward guidance. Earlier in the week, Alphabet fell 9% after missing both revenue and earnings estimates and said it was focusing on costs. While Microsoft beat forecasts for both revenue and net income, its stock also fell 7.7% due to lower growth forecasts for its cloud platform. Apple was a rare bright spot, rallying 7.6% on the day after the release of its results.
We are least preferred on the technology sector, amid pressure from higher rates, slowing global demand, and a rising risk of more earnings downgrades. Instead, we favor value stocks, particularly energy equities, and more defensive parts of the market, like healthcare.
Main contributors - Vincent Heaney, Christopher Swann
Content is a product of the Chief Investment Office (CIO).
Original report - Is there more tech downside to come?, 01st November 2022.