The US Big Tech Bull Case Is Starting to Show Signs of Fatigue
The artificial intelligence hype that has propelled US technology stocks in the past few weeks is showing signs of fatigue.
Tech is the worst-performing industry group in the S&P 500 this month, a sharp contrast to its market-leading 33% gain year to date. Meanwhile, the laggard groups of 2023, such as energy and financials, are leading the gains in June.
Investors’ shift out of tech, and growth stocks more broadly, is benefiting value stocks, or those that sell for low multiples of earnings or sales. On Wednesday, a gauge of global value stocks from MSCI Inc. had its largest outperformance against a growth benchmark since May 2022, while the tech-dominated Nasdaq 100 Index recorded its worst day against the S&P 500 since October.
The nascent rotation reflects in part a growing belief among investors that central banks are nowhere near the end of their campaign of raising interest rates to bring inflation under control, and they’re certainly not about to start cutting rates any time soon.
Higher rates hurt shares of highly valued growth companies the most since they’re priced on their prospects far out in the future, with bond yields used to discount to today’s dollars the value of earnings that companies may not see for years.
“Some investors have been busy convincing themselves that rate cuts were incoming and that we were close to the pivot, but if central banks mean what they say, we’re not there yet,” said Gilles Guibout, a portfolio manager at Axa Investment Managers, in a phone interview. “That’s why some investors may be disappointed and may have to rotate their positions.”
After the massive tech rally since the start of the year, valuations for the tech sectors have soared. Companies in the S&P 500 Information Technology are priced at 27 times estimated earnings, getting close to the record highs of 2021. Investors may not want to chase the sector at that price, especially when bond yields are moving higher.
A surprise rate hike this week from the Bank of Canada helped fuel the shift out of tech, convincing some investors that markets had been too quick to price in a pause in the US Federal Reserve’s rate hiking cycle. Now they’re fretting that stubbornly high inflation and a still-hot job market may warrant a hawkish decision next week from the Fed.
“Higher real rates would disproportionately hurt long-duration growth and tech stocks which still trade at lofty premia to value stocks,” wrote Bank of America Corp. strategists led by Savita Subramanian in a note this week. “Tech has duration risk, and we believe real rates can move higher.”
The tech rally also highlights the extreme concentration risk in the S&P 500 that investors may want to diversify away from. The five biggest companies in the index, all tech-related, account for 24% of the benchmark, near a record high and well above the tech bubble peak of 18%.
“The US equity market rally looks vulnerable, both due to its narrowness and elevated valuations,” Mark Haefele, chief investment officer at UBS Wealth Management, said in an email. “Equity gains continue to be driven by a small coterie of tech stocks,” he said, recommending diversifying portfolios beyond growth stocks.
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