Tech’s correction may go further … why it wouldn’t be the end of the world … how to protect and position your portfolio
The verdict from the financial media is in …
Despite the partial recovery in tech this week, the sector is still due for a bloodbath.
The thing is, they may be right.
In fact, as I write Thursday mid-day, tech is leading the declines in the market, with the Nasdaq down another 1.9%.
Tech could easily drop another 10%, perhaps more.
But the question is “what then?”
Would the stock market “game-clock” suddenly expire, leaving tech investors with massive, irrecoverable losses forever?
Of course not.
So, let’s remove the hysteria and look at a potential, larger tech-correction with an even-handed perspective.
There are three equally-true realities facing tech today:
One, as a broad sector, tech is arguably overvalued.
And it could easily result in more near-term pain for tech investors. This shouldn’t be glossed over, especially if your financial situation can’t absorb losses.
Two, as with any investment sector, not every tech stock will be a long-term winner. So, being intentional about which specific tech investments you’re allowing into your portfolio could mean very different things for your returns.
Three, despite the sector’s current overvaluation, tech is poised to create massive investment wealth this decade. So, whatever near-term pain lies immediately before us will be little more than a speedbump for elite tech stocks in five-to-ten years (perhaps much sooner).
Today, let’s dive into all these details so that we can remove the fear from the alleged tech bloodbath that continues to lurk just around the corner.
***Tech is overvalued
Our income investment specialist, Neil George, highlighted details in his latest Profitable Investing update.
Neil starts by noting that healthy stock market gains are driven by actual business revenue expansion, as well as growing assets.
On the other hand, when stock gains decouple from the earnings power of the underlying business (by racing much higher, in the case of overvaluation), that’s when gains are unhealthy. It sets the stage for bubbles that can pop when investors realize that earnings don’t support lofty market prices.
Here’s Neil with more:
The average revenue gains for the S&P Information Technology members over the past five years have climbed by 10.3% on a compound annual growth rate (CAGR) basis.
But the stocks inside that index have an average annual equivalent return for those five years of 26.2% — 2.6 times greater than their revenue gains.
Over the trailing year, the revenue gains have only increased on a CAGR basis by 5.1%, and yet the stocks in that index have gained an annual equivalent 44.5%, which is an astonishing 8.8 times.
But what’s really disturbing is that the average revenue year to date is actually down by 15.5% (CAGR) while the index has returned an average annual equivalent of 40.7%.
This should be a wake-up call for investors betting that technology will continue to drive stock prices higher.
Neil goes on to note how an examination of the net assets of technology companies (also known as the intrinsic, or book, value) produces even more concern.
The average intrinsic value of the companies the S&P Information Technology Index has only gained an average of 4.1% (CAGR).
Neil’s takeaway is simple — all of the innovative products, services, patents and such aren’t the growth engine for this market.
So, what’s an investor to do?
Neil has the answer again:
The key is to get to know the companies under the hood of the indexes, especially when it comes to technology firms.
And don’t get swept up in popular tech stocks or indexed investments just because they’re getting positive press and newsletter coverage. That’s exactly what happened during the dotcom boom … and bust.
Neil’s warning leads us to our second point — the reality that not every tech stock will be a long-term winner.
***Separating the good versus the not-so-good tech stocks
As our CEO, Brian Hunt, once wrote, “It’s not so much a stock market as it is a market of stocks.”
While it’s easy to think of “the market” — or in this case, the tech sector — as one big monolith that rises or falls in unison, the reality is that it’s made up of many companies with widely-varying fortunes — and futures.
We’d need look no further than market-darling, Microsoft, and, say, Xerox.
By the way, for anyone questioning Xerox as a tech stock, here’s how the company describes itself:
We are a workplace technology company building and integrating software and hardware for enterprises large and small.
Microsoft describes itself as a technology company too. And it makes software, right? And hardware?
Well, that’s about where the similarities end.
Below, we show the two stocks over the last three years. While Microsoft is approaching 200% gains, Xerox has lost 35% of investor capital.
Two tech stocks … two very different impacts on a portfolio.
So, how do you separate the Microsofts and Xeroxs of the world?
Well, we’re clearly partial to our analysts. Neil, Eric Fry, Matt McCall, and Louis Navellier all hold elite tech investments in their portfolios. And our technical experts, John Jagerson and Wade Hansen, regularly trade tech-stock options for gains.
But to try to make this as valuable a Digest as possible, I recommend you use Louis’ free Portfolio Grader tool.
It’s a fantastic way to get a fast snapshot of the fundamental quality of a specific stock. It’s rooted in Louis’ objective, numbers-based approach to the markets.
To illustrate, here’s how Xerox looks through the Portfolio Grader, with a score of “D”:
And here’s Microsoft, with a score of “A”:
All tech stocks are not the same.
Yes, the sector is going to hit some bumps … possibly big bumps … possibly tomorrow, or next week.
But the fundamentally strong tech stocks, like Microsoft, will bounce back and surge higher when the volatility is done. The lesser tech stocks will languish.
On that note, go back and look at Xerox’s stock chart. It’s nowhere close to reaching the market price at which it traded before the coronavirus volatility in March.
***Despite the tech’s overvaluation, elite tech is poised to create massive investment wealth this decade
Two realities …
Top-shelf technology stocks will make investors rich this decade.
At the same time, top-shelf technology stocks will suffer significant drawdowns this decade.
It would be foolish to expect anything different.
Older investors may recall the 2000 dot-com crash, when a certain tech stock named Amazon lost 90% of its value in two years.
We can all agree that wasn’t a knockout punch for Amazon-investors who stuck around.
Several weeks ago, here in the Digest, we profiled a similar series of drawdowns for Apple beginning in 2012.
From April 01, 2012 through May 17, 2012, Apple fell 17% …
From September 18, 2012 through April 19, 2013, Apple fell 44% …
From July 21, 2015 through June 27, 2016, Apple fell 29% ..
From October 4, 2018 through January 3, 2019, Apple fell 39% …
From May 6, 2019 through May 29, 2019, Apple fell 16% …
And from February 13, 2020 through March 23, 2020, Apple fell 31% …
Despite these six double-digit busts, between January 1, 2012 and today, Apple has climbed 781% (after reaching nearly 1,000% before the recent tech selloff).
So, as you read headline-warnings of a looming tech-stock meltdown, pause, and ask yourself …
Are my tech stocks rooted in fundamental strength rather than hype?
Do I have an investment timeframe that can absorb shorter-term market-bruises?
If you answered “yes” to both questions, ignore the headlines. Instead, look to scrape up more cash to take advantage of lower prices if such a meltdown were to materialize.
Have a good evening,
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.