The logos for Facebook Inc., Amazon.com Inc., Netflix Inc. and Google, a unit of Alphabet Inc., sit on smartphone and tablet devices in this arranged photograph in London, U.K. (Photographer: Jason Alden/Bloomberg)

Goldman Sachs Defends Tech Stocks, Says Many Now Look Cheap 

(Bloomberg) -- With tech stocks suffering their worst month relative to the broader market in more than a year, Goldman Sachs has some advice for bears: make sure you’re selling for the right reason.

Elevated valuations and crowded positioning have been blamed for the waning leadership of the market’s biggest industry, along with everything from rising bond yields to corporate earnings. The truth is, computer and software makers are cheaper than they’ve been historically, and fund managers currently hold fewer tech stocks than their representation in benchmark indexes, according to Goldman strategists led by David Kostin.

“Popularity has turned into concerns of overcrowding and outperformance has turned into concerns of overvaluation, ” Kostin wrote in a note earlier this week. “We believe these risks are overstated.”

Goldman Sachs Defends Tech Stocks, Says Many Now Look Cheap 

Specifically, when measured by price-earnings multiples, tech shares traded at a ratio that’s 7 percent above the S&P 500 Index, well below the average premium of 30 percent over the past three decades. And for an industry with profit margins twice as high as the broad market, such a valuation premium is warranted, according to Kostin.

At the same time, the industry is no longer the most loved after internet giants Facebook and Google’s parent Alphabet left last month to join the communication services group. As a result of their exit, hedge funds’ tech exposure now sits 188 basis points below the sector’s benchmark weighting.

The same is true for mutual funds. At an average 158 basis points underweight, large-cap core funds have never shunned the industry like this in the past five years.

Tech shares have tumbled 7 percent this month, trailing the S&P 500 by 2 percentage points, the most since June 2017. The slump called into question the leadership of an industry whose gains in the past three years have doubled the market.

Tech stocks are the latest casualty in a market rout spurred by fears over rising interest rates and a growth slowdown, according to Mike Wilson, chief U.S. equity strategist at Morgan Stanley. He cut tech’s rating in July, advising investors to avoid the stocks.

Kostin remains optimistic, predicting tech stocks will beat the market next year, propelled by solid revenue growth and strong cash flow, much of which are likely to be returned to shareholders in the form of dividends and share buybacks.

©2018 Bloomberg L.P.