Were Tech Stocks Overvalued?

Household name technology stocks have fallen dramatically this year. Pie Funds founder and CEO Mike Taylor explains what could lead to a turnaround in this popular equities sector.

I’m writing this article from 18,000 feet up, on a regional flight within New Zealand. Why do I mention that? Well, often, to gain some perspective on a situation, it’s good to get a view from above. Starting at the end of 2021 and accelerating into 2022, tech stocks have fallen precipitously as rising interest rates and a slowing global economy have wrought havoc for investors. And there has been nowhere to hide, with even the popular FAANGM (Facebook, Apple, Amazon, Netflix, Google and Microsoft) all falling, some over 50 per cent. The Nasdaq Composite stock market index, heavily weighted in technology stocks, was down around 30% by July 2022. You may have investments in these companies yourself, so know first-hand. Or maybe your KiwiSaver provider, managed fund, or index funds invest in them. But, before we get to the recovery, it’s worth understanding if tech stocks were overvalued in the first place.

Covid-19 drove a surge

After a decade of strong performance, when the Covid-19 pandemic hit, tech companies’ profitability was turbocharged. This was driven by consumers and businesses forced to work from home and shop online. You’ll probably recognise this from your own behaviour. You might have been using Microsoft Teams or Zoom programs for the first time, and quickly these became part of everyday life. Bricks-and-mortar retail stores may have quickly set up online shops using technology. At-home entertainment surged – who wasn’t watching increased hours of Netflix?

The market bid up valuations on the assumption we were in a new paradigm. Unfortunately, just as interest rates started to rise, so did the realisation that, although we’d shifted some of our behaviour, society as a whole wanted to get back to ‘normal’.

Three signs of a turnaround

Fast forward to July 2022. We now know that although shopping online and Zoom meetings are great, we don’t want to spend our whole lives online.

The good news is that prices have now adjusted, valuations have returned to earth and, in many cases, tech stocks are relatively cheap. So what am I looking for to signal the allclear and return to investing in the tech sector?

• First, a peak in inflation and for central banks to say rate hikes are over for now.

These will ease pressure on valuations. • Second, I want to see how earnings are tracking in an environment that’s tough for the consumer. If tech earnings hold up as I think they might, then that’s a big tick.

• Finally, I want to see a washout in sentiment towards the sector. And for this, I think we are already there. Tech has fallen so much that I’m seeing plenty of opportunities. Therefore, while I’m still cautious, I think prices for the sector could well be higher in six to 12 months, although it will be bumpy along the way. For long-term investors, it might be time to start nibbling away at your favourite beaten-up names.

Correct as at July 2022. Mike Taylor is the CEO and founder of Pie Funds Management Limited. You can view our disclosure documents on the Pie Funds website. For personalised financial advice, please speak to a financial advisor.