Are Tech Stocks ready to rally again?

Until the middle of last year, tech stocks could do no wrong. The tech sector was a big beneficiary as investors moved away from banks after the 2008 financial crisis.

If you plot the S&P 500 against the Nasdaq (NQ) 100 from 2007 to 2019 you can see the difference in the performance of the two indexes. The S&P gave an annualized return of 9% and a cumulative return of 156%; which is pretty good going. But the NQ gave an annualised return of 13%, leading to a whopping cumulative return of 315%.

This steady growth in the value of tech stocks drove more investment and this increased again during the pandemic years as people envisaged a more digital future. Riding at the top of this NQ wave were the so called FAANG (Facebook, Amazon, Apple, Netflix, Google) stocks, the big tech corporates who could seemingly do no wrong.

Except, all good things come to an end as they say. With the elevated stock prices that resulted from the pandemic, big tech businesses started investing heavily to grow, particularly in staff. However, this has made the bottom line of these companies look bad as profit margins have dropped. They have effectively been investing ahead of the curve, mostly through acquisition. This is fine in a rising market, where sales are increasing robustly every year, but when markets halt or start to fall company valuations come under increased scrutiny. This combined with the Fed's aggressive increasing of interest rates to tackle inflation left these companies looking considerable out of step with the market.

Consequently when stocks started to fall around mid 2022 it was these tech stocks that felt a lot of the pain. And 2022 ended up being a bruising year for tech. Apple dropped 27%, Microsoft 29%, Alphabet 39%, Amazon 50% and Meta almost 66%.

But with the recent turmoil in banking stocks linked to the crises at SVB, Signature and Credit Suisse, tech finds itself in the unusual position of being a haven for investors. Which means that the stocks have been rising: Microsoft (MSFT) is up 15% this year and Apple (AAPL) up more than 20%. What's remarkable is that they both have price/earnings ratios in excess of 25 but buyers are prepared to pay the premium in the expectation of more gains. 

So is this a new rally driven by the company fundamentals? Well structurally nothing has changed so it's more likely to be a bounce on the back of the punishing mark downs from last year. But the question you need to ask yourself is are tech stocks still a good long term bet. There are tech companies out there that have solid business models and strong growth potential, these are the ones you want to target. Remember, recession or no recession, investors value companies that demonstrate consistent growth and strong returns.

Tech is a big sector and it would be wise to think beyond the headline stocks, particularly as Apple and Microsoft combined now account for some 13% for the S&P 500 and 25% of the Nasdaq 100! 

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Useful Links: Common Trading Mistakes, What is a Recession, The Problem with Economic Forecasts, What is Monetary Policy, What is Fiscal Policy, Picking Stocks in 2023, Your Best Shot at Goal, Speculating vs Investing, Profile of a Futures Trader, Invest in Yourself

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