US technology stocks have recently taken a battering. By mid-March, the NASDAQ 100 Technology Sector Index had fallen by 30% from its high in November 2021. The perfect storm of high inflation, rising interest rates and slowing earnings growth has prompted some frenzied trading in tech stocks.
CNBC reports that “macro conditions were already troubling for tech”, leading to investors “fleeing growth stocks”. They add that, due to the war in Ukraine, “The outlook over the past three weeks has gone from bad to substantially worse.”
With some tech stocks falling by 75%, investors may see this as a potential buying opportunity. Or, as with the dot-com bubble, is this the start of a longer slide? Let’s take a closer look at the outlook for tech stocks.
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What are the headwinds for tech stocks?
Having delivered stellar returns, why have tech stocks recently suffered a reversal of fortunes?
1. Soaring inflation
Inflation in the US has risen to nearly 8%, its highest level in 40 years.
Fidelity International reports that “Tech growth stocks have mostly delivered their market-leading performance while inflation has been exceptionally low.” They also point out that “inflation averaged only 1.7%” during the tech stock bull market from 2010 to 2020.
Why are tech stocks vulnerable to high inflation? Well, they compete to attract the best IT professionals, with average tech salaries of nearly $105,000 (£81,000) in 2021, according to a survey by SHRM. While web developers saw their salaries increase by 21%. High inflation adds to the upward pressure on wages, along with the cost of other components.
2. Rising interest rates
Stock markets dropped in anticipation of the Fed increasing interest rates, which Jim Reid from Deutsche Bank describes as “a hawkish pivot toward tightening its monetary policy amid hot inflation.”
One of the methods of valuing tech companies is discounted cash flow. An increase in interest rates reduces the current value of future cash flow and the implied value of the company.
Jim Reid also points to the strong correlation between the FANG+ Index (10 tech ‘giants’) and the size of the Fed’s balance sheet. Quantitative tightening is expected to reduce balance sheets by $3 trillion (£2.3 trillion) in 2025, putting further downward trading pressure on tech stocks.
3. Logistical problems
There is a global shortage of semiconductor chips due to the rising demand for products such as cars and consumer electronics.
Ken England from EY’s US Technology Sector comments that technology companies expect “supply chain constraints to decline in 2022”, but he also warns that “the downside risks remain significant”.
4. Regulatory pressure
Rana Foroohar from the Financial Times states that “Big Tech [is bracing] for a year of regulatory pressure” with lawmakers “taking aim at the big online platforms”.
Facebook is facing an antitrust lawsuit, part of the wider implementation of tech-focused antitrust bills in progress in the US. And there’s also global scrutiny, with Europe implementing laws around data protection and privacy. In addition, a proposed global minimum tax rate could hit companies trading internationally, such as Amazon.
Are tech stocks an attractive investment?
Undoubtedly, there’s been a correction in tech stocks after their long bull run. Given the heady valuations (with Tesla trading on a price-to-earnings ratio of over 1,000), this may have been long overdue. A recent global survey by Deutsche Bank found that 49% of people believed US tech stocks were “in a bubble”.
Earnings growth remains a key driver of valuation. Analysis from Zacks Investment shows average earnings growth of nearly 50% for the five largest US tech companies in 2021. Yet, earnings growth is forecast to drop to 6% in 2022 and 16% in 2023. It seems likely that historic earnings growth isn’t sustainable going forward.
Laura Hoy, equity analyst at Hargreaves Lansdown, comments that the “US tech earnings season was a rollercoaster of emotions”. Meta’s share price fell by 25% on recent results, and she described Amazon’s latest results as “lacklustre at best.”
Despite the downturn in tech stocks, technology is far more embedded in our lives than during the dot.com crash in the early 2000s. And, though US tech firms may be behemoths, they can still be nimble in adapting to new markets. Microsoft recently achieved over 30% revenue growth in its cloud business, and Amazon has delivered 33% growth in its advertising revenue. It seems likely that tech stocks will continue to dominate in the long term.
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How can you invest in tech stocks?
Trading in tech stocks involves more risk than investing in portfolio-based products. Technology-based investments, such as Scottish Mortgage Trust, Fidelity Global Technology fund and the iShares S&P 500 IT Sector ETF, are a good way of limiting your exposure to individual companies.
You can buy US tech stocks via most share dealing accounts. One of our top-rated share dealing accounts, FinecoBank Multi-Currency Trading Account charges $3.95 for US trading.
Alternatively, you can hold technology shares, funds and trusts in an ISA, with no tax on capital gains. Our experts have compiled a list of our top-rated ISA providers to help with this.
The post Trading in US tech stocks? What’s the outlook for 2022? appeared first on The Motley Fool UK.
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