Is it the end of the FAANG era? Why the market has turned against tech stocks

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It’s been a brutal start to the year for stock investors.

In fact, the S&P 500 is off to its worst start since 1939, falling more than 16% so far this year. And the once high-flying tech sector is getting even worse.

Even with Friday’s nearly 4% relief rally, technology nasdaq It’s down more than 25% so far this year.

Many of the tech names that dominated portfolios and outperformed for most of the last decade have seen their stocks plummet in 2022. That includes so-called “FAANG” stocks: Meta (FB), Amazon (AMZN), Apple (AAPL), Netflix (NFLX), and alphabet (GOOGLE).

On average, FAANG shares are down about 37% since the beginning of the year.

Promising tech startups like retail robinhood investment platform and the electric vehicle manufacturer Rivian have also dipped, and work-from-home tech names like Peloton and zoomthat excited investors during the pandemic, they have seen growing losses.

This year’s tech trail has left many market watchers wondering what happened. From recession fears to rising interest rates, it’s obvious that tech stocks have faced a number of hurdles. But should the losses really be that bad?

Some experts argue that the tech sector is now oversold, but the reality is that technology companies may still have the odds stacked against them. This is why.

A year of macroeconomic headwinds

First, technology stocks have been hit by a series of macroeconomic headwinds.the i was in ukraine, COVID-19 lockdowns in China, tangled supply chains, skyrocketing inflation, slow economic growthAnd the list goes on.

As Wedbush tech analyst Dan Ives wrote in a note on Friday, this is “probably the most complex macro backdrop in 100 years.” On top of all that, you have a new “social media world” where every data point can be micro-analyzed by millions, influencing the markets in seconds.

This isn’t great news for stocks in general, but tech stocks face even more headwinds than most. After all, in tough economic times, investing money in risky, often highly speculative assets isn’t most investors’ idea of ​​a smart move.

Instead, many are looking for “safe haven assets” to protect their portfolios, as evidenced by the value stock outperformance other increased demand for gold in the first trimester. That’s bad news for the tech sector.

During this week’s brutal stock market sell-off, tech stocks suffered their biggest drawdowns of the year, with investors pulling $1.1 billion out of the sector, according to Bank of America strategists led by Michael Hartnett.

It’s a sign of “true capitulation” when investors dump their most beloved holdings as they have this week, Hartnett and his team said.

“Fear and hate suggest stocks are prone to an imminent bear market rally, but we don’t think the final lows have been reached,” the strategists added.

A ‘crash landing’

Investors are worried too a recession could be on its way like the Fed raises interest rates to combat inflation. The central bank has been trying to ensure a “soft landing” for the US economy where inflation is under control, but Gross Domestic Product (GDP) growth continues.

But now even Fed Chairman Jerome Powell admits that could be “A challenge.” As a result, both institutional and retail tech investors have headed for exits.

“We think these stocks are pricing in a ‘hard landing,’ and fears abound,” said Wedbush’s Dan Ives.

No wonder why, really. History shows that soft landings are extremely difficult to achieve.

“Over the past 70 years, there have been 14 Fed tightening episodes and 11 recessions, with soft landings only three times, or 21% of the time,” Lisa Shalett, Morgan Stanley Wealth Management CIO said in a Monday note.

The Fed is attempting what Shallet describes as an “unprecedented feat,” simultaneously raising interest rates and reducing the size of its almost Balance of $9 billion.

Throughout the pandemic, the Federal Reserve kept interest rates near zero and leaned toward a somewhat controversial policy called Quantitative Easing (QE)buying billions of dollars in mortgage-backed securities and government bonds every month to increase the money supply and boost lending to consumers and businesses.

While QE helped enable one of the most impressive economic recoveries in history from the recent pandemic-induced recession, it also boosted risk assets like tech stocks.

Now that the Era of “free money” is over, tech investors are worried that we may be seeing the dot-com bubble again. Still, Street always has its fair share of tech bulls, and many analysts argue that this tech selloff will soon be over, at least for most of the sector.

“Simply put, this is not a Dot-com Bubble 2.0, in our opinion. It’s a massive overcorrection in a higher rate environment that will cause a bifurcated tech ribbon with gaps that have and don’t have tech,” Ives said.

The prominent tech bull added that he expects “there are going to be a lot of tech and EV players going out of business or consolidating,” but the biggest names in sectors like cybersecurity and cloud software should continue to outperform in the long run, making This is a “generational buying opportunity”. ” for investors willing to take more risks.

Still, rising rates present unique challenges for technology stocks that are often valued for their ability to grow earnings.

A technology sector appreciating as rates rise

Technology stocks are especially sensitive to rising interest rates due, at least in part, to the discounted cash flow (DCF) models that sell-side analysts use to price stocks. .

In short, DCF models forecast a company’s future cash flows and then discount them to arrive at a value of what they are worth today.

The key factor used in that discount process: that’s right, interest rates.

This means that as interest rates rise, the present value of a company’s future earnings declines. And the higher the expected future earnings growth, the worse the impact of rising interest rates on a stock’s valuation.

So high-flying tech companies, often valued so much not for their profitability but for their growth potential, bear the brunt.

“When rates go up, it forces investors to shorten their time horizons and put less value on cash flows later in the future,” said Dave Smith, Bailard’s head of technology investing. fortune. “Tech tends to have more companies eschew profitability today to invest in future growth. Those stocks have underperformed as rates have risen higher.”

However, Smith noted that despite the “big mistakes” by FAANG companies and ongoing macroeconomic headwinds, sustained outperformance in the stock market is often driven by “organic business growth” and that’s something. that most FAANG names can still provide.

“It may not be as simple as ‘Buy FAANG’ anymore, but we think there are plenty of babies throwing themselves out with the bathwater in today’s fear-driven environment. That is an opportunity for longer-term focused investors,” she said.

This story originally appeared on fortune.com

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