By Tim Courtney, Chief Investment Officer
Tech companies in the U.S. have been dominating headlines in recent weeks amid growing concerns about earnings and growth. After Q3 earnings were reported, Amazon, Microsoft, Meta and Alphabet collectively lost over $350 billion in market cap just in the last week of October.1
Over the past decade, tech companies earnings were growing faster than just about any other industry in the U.S. and over this time frame stocks of these fast growing companies have become quite large. This changed this year though as a portfolio of five of the largest tech/communication stocks (Meta, Apple, Amazon, Netflix and Alphabet) has seen a decrease of 40% YTD.2
There are two primary reasons as to why these companies have been challenged this year. To begin, we have experienced the most aggressive rate hike cycle from the Federal Reserve since the early 1980s.3 Growth companies are among the more sensitive to rising interest and have been disproportionately impacted by the Fed’s hawkish policy. Secondly, and perhaps surprisingly, investors have begun questioning the certainty of earnings growth moving forward. Markets had been most confident about these firms’ ability to grow and avoid the effects of recessions.
As we navigate this new environment for these companies, here are a few important takeaways to keep in mind.
Evaluating tech stocks in the context of the current market environment. As we discussed in a previous commentary, history rhymes but doesn’t repeat itself. There have been some comparisons made between the current environment and the early 2000s. Most of the Big Tech companies today are far more established than the dot-com names of the past. Earnings are of better quality and are much more consistent. Additionally, the valuations of these companies are much lower today than what they reached in 2000. The S&P 500 was trading over 30 on a price-to-earnings (P/E) basis in 2000.4 The S&P 500 is estimated to be trading at a little under 20 as of 11/11.5 Valuations are much more in line with long-term growth averages today than they were two decades ago.
If you desire a diversified portfolio, you likely will need to have some exposure to these large companies. That said, you don’t need to own these stocks in the same weights that the S&P 500 does. Coming out of 2021, the S&P 500 was more concentrated in the 10 biggest names than ever before. We saw something similar occur during the 1970s. Investors flocked to the “Nifty 50,” a highly-concentrated portfolio of growth stocks. This same phenomenon happened in 2000. The last two times market concentration was near this level, the market “broadened” in subsequent years.
Nothing is certain. From 2011 through 2021, large tech firms had a reputation of “certain” and fast growing cash flows. They still do have relatively high quality earnings and growth. However it’s important to remind ourselves that many factors drive earnings and those factors change. Consumer tastes, competition and regulation will all affect profit expectations. As always with investing, there is no certainty or free lunch.
If you have any questions, please contact your Exencial Advisor.
- CNBC (10/28/22) – Big Tech falters on dreary earnings and forecasts for Q4 – Meta has worst week ever, Amazon tumbles 13%
- PortfoliosLab.com (11/10/22) – FAANG portfolio returns
- CNBC (11/2/22) – Fed approves 0.75-point hike to take rates to highest since 2008 and hints at change in policy ahead
- TheStreet (5/20/22) – Why P/E Ratios Tell You Nothing Right Now
- The Wall Street Journal (11/11/22) – P/Es & Yields on Major Indexes
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