The US stock market has been “the” market over the last decade, in large part due to the phenomenal gains from the US tech sector. Indeed, over the last 10 years the Nasdaq and S&P 500 Information Technology sector have returned 18.6% and 20.9% annualized, respectively.
Since the pandemic hit it’s been the only game in town, with the Nasdaq rallying an incredible 75% from the March lows. That was until the beginning of this month when technology stocks pulled back sharply, leaving many to wonder whether the tech rally has run its course, or has much more to go. This is our focus today.
The Nasdaq’s Wild Ride Since the Virus Hit
Source: Stockcharts.com, Turner Investments
Let me begin by stating that this recent pullback should not be a surprise to any investor and only greed could blind you to this fact. Yes, there are many supportive and bullish trends for the technology sector as I’ll touch on shortly, but nothing, even Tesla’s stock price, goes straight up. With the Nasdaq having rallied an incredible 75% since the March lows, tech stocks were ripe for some profit taking.
First, tech stocks had become insanely overbought on a technical basis. The Relative Strength Index (RSI) momentum indicator hit 80 for the Nasdaq in early September (above 70 indicates overbought) and the Nasdaq was trading 28% above its 200-day moving average (MA) – both extreme overbought technical readings.
Second, with the strong price gains valuations for the tech sector had become downright frothy. Below is a chart of the forward price-to-earnings (P/E) ratio for the Nasdaq and you can see how it just “hockey sticked” over the last few months. To start the year the Nasdaq P/E was at 24x and following the huge rally increased to 40x, nearly double the long-term average of 24x. Sure earnings should continue to rise but I’m not sure if enough to support a near doubling of valuations. As Warren Buffet famously said “price is what you pay. Value is what you get”.
Nasdaq P/E Has Surged to 40x Earnings
Source: Bloomberg, Turner Investments
So, given the extreme technical readings and elevated valuations, tech stocks were vulnerable to some profit taking and very well could fall further in the short-term. Currently the Nasdaq is at a critical technical juncture with it trading right at its 50-day MA. If this level fails to hold the Nasdaq could experience another leg lower and I would look to roughly 9,400 (14% lower from current levels) for next major support, which is where the 200-day MA comes in. The next few weeks are going to be very interesting for tech stocks!
The Nasdaq is Trading at its Important 50-day MA
Source: Stockcharts.com, Turner Investments
Now longer term I’m still very bullish on the technology sector given so many supportive trends. They include:
- E-commerce. The biggest tech trend has been the move to online sales. Last year global e-commerce sales rose to US$3.5 trillion, up from US$1.3 trillion in 2014. And with e-commerce sales still only representing 14% of all global retail sales there is still tremendous growth potential. E-commerce sales are projected to hit US$6.5 trillion by 2023, which would represent a 19% compounded growth rate since 2014. Sorry brick and mortar businesses! Amazon came and changed the world (not necessarily sure if in a good way).
- Artificial Intelligence. This is the next big thing and will have far-reaching implications for the labour markets, how we get around with autonomous cars and ridesharing, robotics, computing, healthcare and so much more.
- Cybersecurity. As our whole life moves online bad actors will try to exploit this through those terrible cyber-attacks. In 2018 there were 80,000 cyber-attacks per day in the US or 30 million in total. Cybercrime damages are forecasted to rise to US$6 trillion next year, up from US$3 trillion in 2015. Huge potential!
- Stay at home. All these technology trends we’re already well established but the pandemic only accelerated these even more. We’re shopping online even more as we avoid large in-closed shopping malls, we’re watching a lot Netflix, Disney and Prime, we’re all on Zoom conference calls, while playing the newest video games. It’s crazy to think one event could change the world so dramatically, with many tech companies greatly benefitting from this pandemic, sadly.
- Then there’s automation, Fintech, VR, blockchain, IoT, and don’t even get me started on drones! Those things are nuts!
I see these trends lasting for some time, so I’m bullish long-term on the tech sector. But in the short-term, there could be more downside given the current mania and elevated valuations. Buckle up!
Ryan Lewenza, CFA, CMT is a Partner and Portfolio Manager with Turner Investments, and a Senior Vice President, Private Client Group, of Raymond James Ltd.