The combination has plunged the popular stock sector into a slump, after more than a year of broad technology stock outperformance. The Technology Select Sector SPDR Fund (XLK) is 11.8% off its record close on Jan. 3.
The fear of climbing interest rates that sparked a plunge in technology stocks may be slowing, just as a number of companies now seem cheap.
Growth stocks have been broadly sold off this year as the markets grapple with a new set of dynamics. In our 2022 US equity market outlook, we highlighted that tailwinds that had aided stocks to rise last year have reversed and are now headwinds to further gains. Moreover, we warned investors that the markets looked overvalued coming into the year, as we computed data on a composite of the stocks under our coverage. Specifically, we noticed that the technology sector was one of the most overpriced sectors through our sector coverage.
Stocks have sold off in recent weeks as investors factor in the following dynamics into their forecasts:
Rising interest rates
The majority of the sell-off has come as the market has priced in slowing economic growth and rising interest rates. Growth and many tech stocks have been especially hard hit due to the long duration of their earnings. A large component of the value of technology stocks is their future earnings profile, and when investors lower their growth expectations and/or price their future earnings at a higher rate, the discounted value today of those stocks declines faster and deeper than the overall market. Coming on top of that, market sentiment on growth stocks has soured, especially after Netflix (NFLX) plunged, losing over 20% in one day after last week release its earnings.
Following Sell-Off, Here Are Undervalued Tech Stocks We Identify Now
The stocks we would focus investors on right now are those high-quality companies that we rate with a Economic Moat Rating of wide, which means they have a long-term competitive advantage. We are also narrowing down our universe to ones where they have good price power that they can pass their own cost increases through to in order to protect their own margins. In this market environment, we favor those companies that have stable cash flows and good visibility in terms of their earnings for this year, but also good prospects for long-term growth and large tangible addressable markets.
It’s Not as Bad as the Headlines Claim
However, while the markets have been hammered over the last few trading sessions, the read-through isn’t as grim as the market action suggests. Our forecast for real US economic gross domestic product growth is 3.9% for 2022 and 3.5% for 2023, even with the growth rate slowing. Similarly, although inflation is running hot now and is likely to stay elevated for some months to come, we expect it to begin moderating in the second half of this year and continue to subside further in 2023. Finally, while interest rates are on the verge of rising, let us not forget that they’re doing so from levels that weren’t too far off historical lows.
As believers in a long-term investing philosophy, we do not try to time the market at all, instead seeking to discover mispriced opportunities for investors where the markets are not appropriately discounting the long-term value of a company. After the broad sell-off so far this year, we find several stocks in the technology sector that have been pushed down too far during this market rout and offer good opportunities for investors today.
