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Is it still worth holding on to US tech stocks?

The once darling of Wall Street, US tech stocks, had mostly stumbled through 2018. While the sharp decline in prices had improved valuations, the uncertainty in outlook nevertheless clouds prospects for this stock market engine.

What happened to US tech stocks

US tech stocks suffered a steeper stage of pull-back into the end of 2018, with prices edging close to bear market territory as we pen this. Gone it seems are the days where tech stocks had been the engine of growth for US equity indices, pushing the latter towards one all-time high after another.

While most of the specific reasons that had weighed down upon Facebook, Apple, Amazon, Netflix and Google stocks (FAANGs) had been documented by us earlier, the more sinister turn in market sentiment that took place into the year-end appears to have underpinned the plunge for prices into the abyss.

Reasons for recent US tech stocks sell-off

Fundamental, technical and sentiment drivers work hand-in-hand to shape price movements for markets. At any point of time, however, one element may play a bigger role than the rest, such as with the market sentiment currently. The reasons for the latest bout of concerns had centred two key items, including the US-China trade spat and a less dovish than expected Federal Reserve (Fed).

One would question how the above links up. On the surface, the US-China trade spat invokes worries of demand for US tech stocks, whether this is from a tariffs perspective or the currency impact. More crucially, US President Donald Trump’s threat on the inclusion of Apple products that had previously been exempted had hit at the heart of US tech stocks. Certainly, the current 90-day truce period arranged following the Trump-Xi talk had kicked the issue down the road, but the market had not stopped at feeling distraught about the prospects.

Meanwhile on the Fed outlook, despite the latest paring down of interest rate hike consensus for 2019 and the longer run, the Fed had managed to project themselves to be less dovish than the market expectation. Concerns of growth, particularly with the inversion of parts of the US treasury yield – a widely regarded precursor for recession, had induced the market to harbour high hopes for the Fed to extend support. Fed chair Jerome Powell’s persistence in his confidence on the outlook and the balance sheet reduction among others had however dashed this. Not to mention, the market’s view on approximately one hike to match the economic situation in 2019 sits below the Fed’s two hike expectations. This could have strong implications for the highly growth correlated technology sector down the line, creating the current state of play.

How to trade US tech stocks sell-off

Having highlighted the reasons for markets to be cautious with US tech stocks going into 2019, surely, the improved valuations would help to balance some of the gloom with earnings still expected to grow in the coming year, one would ask. The issue in hand, however, is also the reduced earnings prospects that unfolded alongside the tapering of the price-to-equity (P/E) ratio for the sector.

The S&P 500 index’s information technology sector’s P/E ratio had trimmed to the likes of approximately 17 into the end of the year, seemingly a steal compared to levels above 20 that we have grown used to. P/E ratio, as the name suggests, is the ratio of the current share price to the earnings of each share, one of many forms of measurement on how expensive the share in question is. One would recall, the market had often been told to ignore the high valuations in 2017 simply because of the growth prospects. For the same reason, markets are now concerned, as the most recent poll by FactSet as of 14 December 2018 suggests that a single digit earnings growth is to be expected for the first three quarters of 2019, a stark contrast to the 25% average for first half (H1) of 2018. With such prospects in view, the worst may yet to come for US tech stocks if trade talks with China sours.

The lack of clarity is apparent here at the turn of the year, although this had also contributed to the downtrend for the S&P 500 index’s technology sector ETF (XLK ETF) − one way to gain exposure to US tech stocks. Look to how the US-China trade item will pan out among others that could shift the direction for price trajectory in the medium term amid slowing growth expectations. The short-term outlook for the tech sector, however, may have little bright spots to count with the downtrend still in play.

This information has been prepared by IG, a trading name of IG Markets Ltd and IG Markets South Africa Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer and quarterly summary.

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