Technology: A sell-off or buying opportunity?

Friday 9 June saw a sell-off in US technology stocks led by heavyweights Facebook, Amazon, Apple, Microsoft and Google parent Alphabet, taking the Nasdaq Composite index down 2.4%. A bearish note from Goldman Sachs was to blame, but is this rally the beginning of the end, or a chance to pick up market leaders for less?

The market cap of these five stocks has increased by some $660 billion (£522 billion) from the start of the year to 7 June, according to Goldman. The broker points out that these big-hitters are behind around 40% of the S&P 500's performance and 55% of the Nasdaq in 2017 (see table below).

Technology shares in markets as far afield as South Korea and Europe have also been negatively impacted. And that sell-off has continued Monday, with the Nasdaq down a further 1.5% to a three-week low.

Buyers have been out in force, picking up stock at lower prices to drag the index off its worst levels. However, it remains to be seen whether this is a short-term correction and buying opportunity, or a more structural re-rating of a sector that looks expensive on a valuation basis compared to others.

Goldman Sachs pulls the rug

A Goldman Sachs report last week was one of the triggers for this sell-off, as it highlighted the fact that low volatility may be exposing investors to higher risks than they realise. The report described a "valuation air pocket" affecting the tech sector.

The report noted that these five large-cap tech stocks, which Goldman has dubbed the FAAMGs, have surged this year.

"FAAMG, as well as tech more broadly, is increasingly correlated with both growth and momentum," it writes. "FAAMG stocks are cyclical growth stocks that have increasingly been treated like stable staples with a similarly negative correlation to interest rates and even lower realised volatility."

Long-term drivers intact

Stuart O'Gorman, manager of Henderson Global Technology, says the long-term drivers of technology remain intact as the sector continues to take share versus the old economy, driven by demographics and innovation.

"The relative valuation of the sector is attractive, especially given the balance sheet strength. Tech will continue to be impacted by macro weakness and currency volatility but the long-term drivers for technology remain intact. These include innovation leading to better and cheaper tech products, technology continuing to take share of wallet from both enterprise and consumer, and more will be spent on tech as it becomes increasingly prevalent in everyday life.

"Additionally, tech valuations are still attractive on a relative basis and the sector is expected to continue outperforming the wider market in the longer term."

According to data from Factset, the technology sector is tipped to report the second-highest second-quarter earnings growth (9.3%) and revenue growth (7.6%) after energy of all 11 sectors making up the S&P 500.

The forward 12-month price/earnings (PE) ratio for the technology sector is 19. This PE is above the five-year average (14.7) and the 10-year average (14.4), but well below some other sectors such as energy and defensives.

It's also far more aligned to future earnings than valuations seen during the dotcom boom, so fears of a crash appear misplaced.

Is it too early to say there's a bubble in tech stocks?

A market sell-off is typically accompanied by a spike in volatility, and so it is with the chart above plotting the Nasdaq 100 Volatility Index against the Nasdaq 100.

Divergence between the underlying index and volatility is at extreme levels, but the Volatility Index remains at depressed levels compared to the 2000s.  

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.