Bleak Message of Economic Pain Underlies Tech’s Market Dominance
(Bloomberg) -- Every day is the same in the stock market. The biggest equity benchmarks trade sideways, while megacap tech marches upward.
The Nasdaq 100 has beaten the S&P 500 for seven straight days, five straight weeks, 10 straight months. The tech-heavy gauge is up 23% this year, and since June 8 has beaten the broader market by 10 percentage points.
While that’s manna for bulls who own market proxies, it is also -- at best -- a mixed economic signal. As stirring as the rally has been, the whole thing can also be read as proof investors see the pandemic lockdown hanging around. Every time an automated, algorithmic Fang stock rallies, the theory goes, hopes for a speedy recovery in employment and consumer spending take a hit.
Stated differently: the main thing that could stand in the way of more outperformance is an end to the recession.
“If things get better, if the broader investment environment looks more attractive, then investor appetite for risk, for value, a broader swath of securities will improve,” said Lauren Goodwin, economist and multi-asset portfolio strategist at New York Life Investments. “So you’d see tech lose on a relative basis.”
Plotting the Nasdaq 100’s velocity against the S&P 500 shows its ascent has been interrupted twice since the pandemic outbreak. Tech shares fell behind at the bear market’s bottom in March, when Federal Reserve’s stimulus eased concern over insolvencies. Tech also trailed from mid-May to early June, with hopes for economic reopenings prompting investors to scoop up airlines and companies hit the most during the Covid crash.
Both times, tech stocks -- the stay-at-home trade -- rebounded once fears over the economy or a second wave of virus infections resurfaced.
Lori Heinel, deputy global chief investment officer at State Street Global Advisors, says looking out over the long-term, there’s potential for a sharp recovery in economic data and corporate earnings, especially if a vaccine is developed.
“If we’re right about the idea that we’ll see a bit of an improvement in the economic backdrop in the balance of this year and into 2021, we think that there’s just better opportunities in other sectors,” Heinel told Bloomberg TV this week. Her team is generally underweight FANG stocks but overweight tech.
What else could trip up tech? Though it hasn’t mattered to date, valuation remains a concern. At 31 times forecast earnings, the Nasdaq 100 is trading at the highest multiple since 2004. By most traditional absolute measures, the index’s valuation is “extreme,” according to Michael Purves, chief executive officer if Tallbacken Capital Advisors.
“Clearly there has been a lot of good news built into valuations at this point -- they’re going to have to deliver on that good news,” said Mark Heppenstall, chief investment officer at Penn Mutual Asset Management. If there are signs from earnings calls and releases that the new environment hasn’t been as favorable to tech stocks as investors seem to be pricing in, “that would be the most likely cause that would give people pause.”
Many tech firms are scheduled to post quarterly results before the end of the month. Netflix is reporting next week. But given their monster run-ups, analysts are already starting to express some skepticism. Deutsche Bank strategists this week, for instance, conveyed surprise about the speed and magnitude of Apple’s rebound, adding that it “has us nervous.” Raymond James echoed that tone, citing uncertainty around the firm’s forecast given expected delays in the iPhone 12.
Read more: Runup in Tech Mega-Caps Sows Doubt Before Key Earnings Reports
Also omnipresent for the tech sector is the risk of regulations, taken up by policy makers on both sides of the political spectrum. The breakup of big tech firms, especially, has become a focal point. Apple faces antitrust probes in the European Union and U.S. over rules it imposes on developers. In May, Bloomberg News reported that the U.S. Justice Department is drafting a lawsuit against Alphabet Inc.’s Google, accusing the internet giant of violating antitrust laws. The department is on track to file a complaint this summer.
More recently, Facebook has come under fire for its market power, its failure to protect privacy, police hate speech and curb political disinformation. A backlash by major advertisers, including Unilever NV, Coca-Cola Co. and Starbucks Corp., sprung up over concerns about ads appearing next to inappropriate content on the platform -- with some analysts arguing that it could embolden Congress to take its own action.
To Matt Maley at Miller Tabak + Co., regulatory scrutiny could intensify, especially as the presidential election starts to heat up. Policy makers have been “holding back on these things so far this summer because their proposals would have been lost among the Covid and social tension issues,” said the firm’s chief market strategist. “Once the real campaigns begin after the conventions, this bipartisan issue will be pushed in a more prominent way by our members of Congress.”
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