Investors across the pond – and elsewhere – have been taken aback by the severity of the recent tech sell-off. At the time of writing, the NYSE FANG+ Index is down 10.3 per cent over the past week. Bad news for a lot of 401(k) holders, and pension pots this side of the divide, although growth stocks in this space have been defying gravity for some time.
Whether investors have been overtaken by events is debatable given that most probably knew that valuations for many tech stocks were difficult to justify in terms of forward earnings. Therefore, adjustments to future earnings profiles through increased discount rates were always likely to be severe: a lot of ‘blue sky’ assumptions were baked into valuations. The reason why growth stocks were on a tear for so long has as much to do with lax monetary policy as it does with the digital transition, although the latter dynamic is certainly not illusory.
Central banks have been kicking the can down the road for the best part of 15 years, so we shouldn’t be too surprised by the current reckoning, although many investors will be minded to take profits at this juncture. It’s only odd that it took so long for inflation to leech into the system.
True, Russia’s invasion of Ukraine and ongoing pandemic-linked supply chain issues have had a significant impact on consumer prices. But with the US money supply hitting an all-time high in December 2021, you could argue that monetary policy itself is the primary reason behind the commodity price surge that threatens aggregate demand levels in the global economy.
Slowing economic growth and the prospect of further rate rises to check inflationary pressures are undermining valuations in the most overstretched corners of the market. Yet market sentiment turned negative on growth stocks as early as the first quarter of 2021. In the prior year, growth stocks had outperformed their value counterparts by nearly 40 per cent. But it’s worth remembering that a higher proportion of growth (or immature) stocks’ cash flows will accrue in the distant future, so they tend to be more sensitive to higher interest rates.
It will be interesting to find out what advocates of behavioural finance make of current market volatility. It may be that, in certain instances, excess liquidity in the market has been hiding a multitude of sins.
It’s sobering to think that the share price of Netflix (US:NFLX) increased by 339 per cent between May 2017 and the end of October 2021. Those gains have largely evaporated now as the limitations of its business model are brought into focus.
The streaming service does not rely on cable subscriptions and relationships with a telco, which drives down the cost of distribution. The fact that punters can cancel their subscriptions at a moment’s notice means that Netflix needs to fund original content to keep them interested – a prohibitively costly affair – so the company is transitioning to a hybrid offering that is set to incorporate advertising revenues.
Analysts had repeatedly warned that Netflix was spending more and more to acquire new subscribers, but the market seemed transfixed by the growth in subscriptions rather than their impact on net cash flows. The lockdowns played their part as home entertainment surged, but the initial support it enjoyed was intertwined with excess market liquidity.
So, what are our best options now the tide is pulling out? Well, beyond going down the Benjamin Graham route, it could be that the tech reversal is simply separating the wheat from the chaff, presenting opportunities for investors as tech multiples come down to earth.
Amongst Netflix’s FAANG stablemates, it is true that Amazon (US:AMZN) lurched to a net cash outflow in 2021, effectively cancelling out the $5.97bn (£4.59bn) gain of the prior year, while Apple (US:AAPL) has just been supplanted by Saudi Aramco (SA:2222) as the world’s most valuable corporation. That may have raised eyebrows, but you could argue that both companies, along with Google overlord Alphabet (US:GOOGL), are supported by strong moats, antitrust issues aside, whereas prospects for Netflix and Meta (US:FB.) are far from assured over the long haul.
The tech space isn’t confined to the much-vaunted FAANGs, and it’s not as though developments in artificial intelligence, cloud systems and cybersecurity are grinding to a halt. However, the shake-out may have some way to run, so once you perceive that volatility has passed its peak, you could employ a dollar-cost averaging strategy, whereby you invest equal monetary amounts in your preferred tech stock(s) at regular intervals, effectively smoothing out risk.
