Our Wired World

What’s Next For Tech?

Recovery is likely but tech may no longer lead the market

New research from Fidelity’s Viewpoints blog takes a closer look at tech-stock and the bull market that appears to be slowing. Reprinted with permission. Visit here for more details.

For much of the past decade, stocks of technology-related companies drove the overall markets skyward. That long bull run ended painfully this year with a selloff that’s hit most stocks. But the tech sector has been among the worst performers.

Is it time for investors to go shopping for tech bargains, or should they view lower prices as a sign that tech’s time is over?

Tech Or FANGs?

The answer to that question may depend partly on what you mean by tech. According to the Standard & Poor’s system of classifying stocks, the technology sector includes companies that make and sell hardware, software, semiconductors, electronic equipment, and commercial data processing. That includes big-name hardware and software companies such as Apple (AAPL), Intel (INTC), and Microsoft (MSFT). But it no longer includes big internet-based media and retail companies such as Meta (META), Alphabet (GOOG), Amazon (AMZN), and Netflix (NFLX). In 2018, S&P moved the “FANG” stocks (for Facebook, Amazon, Netflix, and Google) from the technology sector to the new communication services sector.

Even with its FANGs removed, the tech sector that you get exposure to in a typical tech index fund generally includes big-name hardware and software companies such as Apple, Intel, and Microsoft. Beyond these superstars, though, many other tech sector members have historically been relatively modest performers. But that may be changing, according to Fidelity Global Technical Strategist Roy Justice. “I think in the future we may see a broad base rather than just a handful of stocks driving the whole sector,” he says. Justice believes that after a steep rise and a sharp decline, tech stocks are coming back to a sustainable, long-term pace of advance. “I think what’s happened this year is very healthy and gives me more confidence in the long-term view of technology. Looking out a year or two, I have a high degree of confidence that technology is going to make significant gains. Over the next 3 to 6 months, I would be less confident in that,” he says.

Director of Quantitative Market Strategy Denise Chisholm also agrees that tech’s worst days are likely over, but she warns that its best days may be as well. “Last year, technology led the market on the downside. Now I think it’s more in the middle—not leading on the downside or the upside. When I look at technology, I see valuations facing modest headwinds and the rest of the signals are meh.”

What About The FANGs?

Will Danoff, the veteran manager of Fidelity® Contrafund (FCNTX), says he continues to favor mega-cap stocks that are sometimes misidentified as tech. “I remain bullish on growth-oriented companies that are gaining market share with innovative products and services. Past examples include Amazon, Meta, and Netflix, two companies that I have considered to be tech leaders even though they are classified in other sectors,” he says.

Institutional Portfolio Manager Mike Hickey explains that reduced valuations don’t change the fact that Amazon, Meta, and Alphabet have few competitors, growing businesses, and very high barriers to entry by potential rivals. “We still have big commitments to these types of stocks, which have corrected meaningfully through the year. Alphabet, Meta, and Netflix are currently trading around 15 times their earnings. Amazon’s always been more expensive given it’s highly unlikely that anyone is going to create another Amazon.com and Amazon Web Services is a super-high margin business,” he says. “These multiples I would say are very fair. The question going forward becomes, ‘How big can their markets get and how quickly can you grow something that big?’”

From 2017 through the pandemic, technology was the only sector that outperformed. Now, I think we might be moving to a more balanced market where other types of stocks like consumer discretionary have odds of outperforming too...

Fidelity® Contrafund held securities mentioned in this article as of its most recent holdings disclosure. For specific fund information, including holdings, please click on the fund trading symbol above.

When Is The Recovery?

Despite the long-term optimism about tech and FANGs alike, the current economic environment may continue to present short-term challenges. Hickey says high inflation and rising interest rates are putting pressure on companies’ earnings. “We probably need to see a durable rollover in inflation that would put a lid on interest rates. That would be a more constructive environment next year and into 2024.”

Chisholm agrees that inflation is a significant obstacle to a tech recovery. “History shows that tech growth stocks have typically struggled when inflation has been high. Their market-leading performance mostly came while inflation was exceptionally low by historical standards. The tech bull market ran from 2009, when the consumer price index actually declined, through 2020 when inflation averaged only 1.7% per year,” she says.

Tech has underperformed during inflationary periods regardless of the health of the economy. Indeed, since 1962, technology has performed poorly relative to the overall market not only during inflationary economic booms, but also at times when inflation has been high despite slow economic growth, an unusual situation referred to as stagflation. If inflation slows meaningfully, tech’s recovery could arrive sooner. Periods of declining or slower-growing inflation have seen better relative results for the sector.

Tech has often trailed during inflationary periods, regardless of the state of the economy. Historical tech sector odds of outperformance by inflation and growth scenario (year-over-year), 1962–August 2021

Double-Down Or Diversify?

While high inflation may vex tech for a while yet, the sector may hold attractive opportunities for investors with longer time horizons by offering them exposure to future growth potential at relatively low current prices.

That doesn’t automatically mean you should load up on tech while it’s relatively cheap, though. Because tech and the FANGs were the source of much the S&P 500’s return over the past decade, you should first understand whether you’re one of the many investors who may already have more exposure to these stocks in mutual funds or exchange-traded funds than you might realize. A lack of diversification can be a source of risk.

Chisholm says this may be a good time to look beyond tech and diversify your portfolio with stocks she believes may offer better opportunities. “From 2017 through the pandemic, technology was the only sector that outperformed. Now, I think we might be moving to a more balanced market where other types of stocks like consumer discretionary have odds of outperforming too.”

Investors who want to find long-term opportunity in technology stocks may want to consider professionally managed accounts, mutual funds, and exchange-traded funds (ETFs).

 

 

Past performance is no guarantee of future results. Analysis based on top 3,000 stocks by market capitalization. Percentages refer to historical likelihood of quarterly performance in various scenarios. Inflation reflects core CPI. Sources: FactSet, Fidelity Investments, as of Aug. 31, 2021