Fed moves have tech investors re-thinking positions
Updated
The US Federal Reserve’s latest meeting minutes have prompted tech stock investors to re-think their investment strategies, analysts say.
But some tech stocks will still find room for growth.
Tech stocks declined for the second straight day Thursday after the release of the Fed’s December meeting minutes on Wednesday prompted a sell-off. The minutes set the stage for forthcoming tighter Fed fiscal policy as the US economy continues to respond to the Covid-19 pandemic.
David Sekera, Morningstar’s chief US market strategist, said the market is adjusting after tech stocks were highly overvalued heading into 2022.
“After the Fed minutes came out, I think the sell-off really was more in the growth stocks in general,” Sekera said, in an interview with Capital.com. “Of course, tech stocks certainly make up a large portion of that (growth-stock segment.)”
Tech stocks re-evaluated
Sekera said tech stocks were overvalued 13% coming into this year. Their valuations have retreated 4% and could retreat another 7% or 8% before the tech sector is fairly valued, he added.
“I think this was also an opportunity for people to re-evaluate the valuations that they've placed on tech stocks,” Sekera said. “The Fed minutes (document) itself has certainly raised the concern among investors, that the Fed is not only at the point where we're easing off the accelerator regarding monetary policy, that they're tapering the asset purchase program, but that they are now getting to the point where they would actually now move over and put their foot on the brake – as opposed to before, where we had some of the easiest monetary policy in history.”
He said small-cap stocks provide investors with the best value today. But the tech sector still contains “pockets” that are undervalued.
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Small caps undervalued
In Sekera’s view, such undervalued tech stocks include VMWare, Zoom, Splunk, Salesforce, and Sensata.
“There's always companies where we think the market is missing the long-term underlying value of the business,” he said. “VMWare, it would be one I would point to that we think is undervalued, that the market isn't getting the long-term view of the company.”
In Morningar’s firat-quarter 2022 North American equities outlook, he said the tech sector was a strong market outperformer at the beginning of the Covid-19 pandemic and outperformed the broader market through most of 2021, including the fourth quarter. But he suspects that strong performance among megacap tech stocks is masking underperformance from smaller technology company shares.
But Morningstar remains bullish on the key secular tailwinds within the tech sector, such as cloud computing, 5G networks, and the Internet of Things. Morningstar views software stocks as fairly valued after their values pulled back.
“We still see some attractive margins of safety for investors in large-cap software but also some of the high-flying remote software stocks that ripped higher in 2020 but have fallen out of favour more recently,” Sekera wrote.
Risk-off trade in effect
Wedbush said risk-off trade is now in full effect and was sparked by the Fed’s hawkish December after fears had been percolating for a month surrounding the central bank’s impact on tech stocks.
In a research report that he provided to Capital.com, Ives noted that high-multiple tech stocks are now down 15% to 20% due to the “massive and brutal” sell-off.
“Is this the end of the tech party or is it a major buying opportunity during a white knuckle sell off?” Ives wrote. “Our answer emphatically is that many of the secular tech winners we believe will drive the 4th Industrial Revolution are now in oversold territory with valuations we find very compelling given the outsized growth prospects over the next 12 to 18 months.”
Tech investments risky
He said tech investors should expect to take a rollercoaster ride in 2022 due to the Fed backdrop, inflation worries, the global chip shortage, and fears surrounding the Covid-19 Omicron variant.
“While the December Fed minutes were the straw that broke the camel's back (Wednesday) after a brutal start to the year for tech investors, we caution this is not the time to throw in the white towel on the tech bull cycle,” Ives wrote. “We have covered tech stocks for decades and seen the tech bubble burst of 1999-2000, financial crisis in 2008-2009, and the bull run since with many nervous moments/crisis events in between.
"To this point, with enterprises/governments set to spend $1 trn on the cloud transformation over the next decade and next-generation areas of spend in cybersecurity, big data, and 5G fuelling the digital transformation, we are seeing growth prospects (two to three times) normalised levels. So while we can fret about the Fed, 10-year spikes, and macro noise, the underlying growth in the tech sector (which is being underestimated by investors) is unparalleled to any period of time we have seen in the last 21 years covering the tech sector on the Street.”
Apple and Amazon favoured
Ives listed Apple and Microsoft among his large-cap favourites, while Zscaler, Palo Alto Networks, Tenable, and CyberArk topped his cybersecurity stocks list. Wejo ranked as his favourite big data stock while Matterport qualified as his favourite digital/metaverse name.
He listed Pega, Progress, Checkpoint, Consensus, NICE Systems, and Ziff Davis as top value tech stocks “which could be safety blanket names during the storm.”
Both Ives and Sekera expect to see a number of tech company mergers and acquisitions this year. Ives views Qualys, Varonis, Sailpoint, as top Cerence M&A candidates.
“We believe M&A (activity) will significantly accelerate in 2022 especially in the cyber security space given the massive growth prospects ahead as part of this cloud shift,” Ives wrote.
Sekera said strong underlying fundamentals – including low long-term interest rates, tight corporate credit spreads, ample capital in the bond markets, and large appetite from private-equity investors and special purpose acquisition companies – point to a strong M&A market in 2022.
“I would expect that we'd see another strong year, both in the number as well as the dollar amount of M&A,” Sekera said.
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