By Louis Krauskoff
NEW YORK (Reuters) – Hopes that inflation will abate are fueling a boom in technology and big stocks, although some investors believe that still high valuations and doubts about corporate earnings outlooks may make a continued reversal out of reach.
The heavy Nasdaq Composite is up 8.1% this week to post its biggest weekly gain since March, one of several eye-catching market moves that also saw Treasuries rise and the US dollar tumble after weaker-than-expected inflation data on Thursday stimulated hopes. The Federal Reserve could ease the rise in interest rates.
Despite these recent gains, some investors are reluctant to jump on the rebound in shares of companies such as Amazon.com Inc, Microsoft Corp and Alphabet Inc, Google’s parent company, which have faltered badly this year after rallying leading markets for more than a decade.
Few believe that the Fed will be affected by a single inflation indicator, and previous bounces fueled by optimism about the Fed this year have collapsed after discouraging economic data or a pullback from policy makers.
At the same time, valuations of the technology sector remain well above the market as a whole, while analysts are obscuring their earnings forecasts for the group.
While lower interest rates could drive near-term demand for stocks, “we think there is still some concern about valuation and earnings,” said James Ragan, director of wealth management research at DA Davidson. “We’re not really looking for those segments to regain market leadership.”
Next week, investors will be watching a flurry of economic data, including Wednesday’s retail sales figures, for more clues as to whether the Fed’s monetary tightening is cooling the economy.
Technology and growth stocks have been hit hard this year, with the Russell 1000 growth index continuing to fall 25% for 2022, compared to a 16% drop for the S&P 500 and a 7% drop for the Dow Jones Industrial Average. Technology sector funds have seen $14.2 billion in outflows so far this year, putting them on track for the first year of outflows since 2016, according to Refinitiv Lipper data.
Price drops have moderated valuations, with the S&P 500 tech sector trading about 21 times forward earnings estimates versus 28 times at the end of 2021, according to Refinitiv Datastream. That level, still more than 17 times the earnings of the Standard & Poor’s 500, is still too high for some investors.
“They are trading at a decent premium to the S&P Index,” said Andrew Slimmon, US equity portfolio manager at Morgan Stanley Investment Management. “There are a series of stocks that will perform much better than the big companies because they re-rated them a lot less.”
Several major technology and growth companies, including heavyweights like Amazon, Microsoft, Alphabet and Facebook’s parent Meta Platforms, posted third-quarter earnings reports that disappointed the market.
Technology and technology-related companies that account for less than a fifth of the S&P 500 index so far account for more than half of the negative fourth-quarter earnings revisions, according to Credit Suisse.
Still, some investors are considering increasing their positions in tech stocks and big companies if further evidence of easing inflation emerges.
One key factor is whether Treasury yields, which move inversely with prices, continue their stunning decline this week. Higher returns can significantly affect technology and growth stocks, whose valuations tend to rely heavily on future earnings which are discounted heavily as returns rise.
The US 10-year bond yield fell to a five-week low of 3.818% on Thursday after posting its biggest one-day drop since the daily decline in more than a decade.
King Lip, chief strategist at Baker Avenue Asset Management, described Thursday’s CPI news — with an annual increase of less than 8% for the first time in eight months — as a “big bargain.” He added that if bond yields continue to fall, “the pace at which people reduce their exposure to these big-cap technology names will slow down.”
Lieb said the company underestimated the weight of large-cap technology and growth stocks, favoring smaller, value stocks.
Ultimately, much will depend on whether inflation shows further signs of easing. The Fed will get another CPI reading before the bank’s policymakers meet again in December.
“If inflation continues to subside, technology is a good place to invest right now,” said J. Bryant Evans, portfolio manager at Cozad Asset Management. “They certainly could lead the way out in an environment where the Federal Reserve is cutting these rate increases that it has been doing.” (Reporting by Louis Krauskopf; Editing by Ira Yosibashvili and Richard Chang)
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