The recent pullback in technology stocks strikes us as a normal bout of profit taking after the sector’s strong run. Although the broad-based sell-off can be unsettling for investors, we believe that the powerful secular trends underpinning the technology sector’s most appealing long-term growth stories remain intact. The digitalization of the economy has shown signs of accelerating, from growing adoption of e-commerce, online advertising, streaming media, and cloud-based software to the proliferation of semiconductors in the automotive and other industrial end markets.
Over the eight months ended August 31, 2020, information technology (IT) had outperformed the S&P 500 and the index’s 10 other sectors by a meaningful margin. The companies with the five largest weightings in the S&P 500 at the end of August—Apple, Microsoft, Amazon.com, Facebook, and Alphabet (Google’s parent company)—also fared well, accounting for more than 800 basis points of the index’s return over this period.
For many tech stocks with well-understood growth stories, valuation multiples based on trailing financial results or consensus estimates for the next 12 months reached levels that looked increasingly demanding. On this basis, rapidly growing enterprise software companies appeared to face especially high expectations. Worries about valuations and the economic uncertainty stemming from the coronavirus pandemic and the upcoming US presidential election meant that investors often wondered how much higher prominent technology stocks could go as they climbed the proverbial wall of worry.