- To see why a leveling of tech valuations has the capacity to terrify even staunch stock bulls, consider the hyper-speculative software makers at the center of the recent equity storm.
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The firms that have suffered a lot in the last few weeks have suffered a blip in the last few weeks due to the hawkish shift by the Federal Reserve. The tech shares lost a third of their value when measured via indexes compiled by Goldman Sachs Group Inc. But even with those losses behind them, the group has a basket of companies that have in many cases yet to materialize - still trades at 16 times sales. It is almost three times the number of the Nasdaq 100 Index.
More established firms aren't in a hurry to make a deal. The S&P 500 Software Services Index has a price-sales ratio of 9, higher than its five-year average of 6.8.
Big down days are multiplying in markets due to a surge in bond yields. While bulls may take comfort in earnings expectations that remain intact, a selloff based on a valuation could be worse news for investors, given how stretched prices became after three giant years for the Nasdaq 100.
Higher interest rates suggest a healthy economy, but they also have a deflating influence on how future profits are valued. It is a concern for technology companies that need a long time to make the profits implied by their market prices.
While veterans of the meme stock frenzy might consider valuations tools quaint, the metrics have proved to be an accurate predictor of which companies were most vulnerable as interest rates started to rise. It is a point that may be worth heeding at a time when the Federal Reserve has just begun a tightening cycle that may take years to complete.
Existing multiples suggest that many of these firms will go on to dominate their industries - a scenario that Michael Purves finds hard to imagine. Some don't make money at all, leaving them vulnerable to a shift in investor taste. Cheap stocks are in favor right now.
Purves, the founder of Tallbacken Capital Advisors, said that it was absurd to pretend that every stock is really exciting and is going to be the next Google. The excitement of exploding risk assets is going to be a little bit more nuanced, as the Fed is going into this new phase. The appeal of software makers as a pandemic caused a mad dash into them among professional and retail investors, sending their valuations sky high. At peak last year, expensive technology stocks accounted for almost 20% of the hedge funds exposure, according to the data compiled by Morgan Stanley s prime broker.
As the selloff began in the speculative corners, hedge-fund managers had to unwind their crowded tech bets at a furious pace. In more than 18 months, their exposure has fallen to the lowest level in more than 18 months.
Computer-driven traders blamed the rout, as the flagship ARK Innovation ETF ARKK lost half of its value from its 2021 peak. She said in a podcast on Jan. 7 that she is confident in investing in companies like Zoom Video Communications Inc., saying industry innovations such as artificial intelligence and blockchain technology are unstoppable. What is going on right now is irrational, Wood said. Mike Wilson, chief U.S. equity strategist at Morgan Stanley, is less sanguine. He pointed out that the recent selloff in software stocks coincided with a downtrend in the industry's profit revisions breadth relative to the market. There was a deterioration in earnings sentiment that was also a factor in the carnage, as rate angst fueled the carnage.
Software as an overall cohort should not perform well until this reverses, particularly if rates still rise, Wilson wrote in a note to clients Monday. We wouldn't recommend investors try to be too early, given the extreme valuations and positioning for the sector. A $13 Billion Bet that Air Travel Will Soon Take Off is not a $13 billion bet.
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