Long Read  

Is it worth staying with tech funds?

Is it worth staying with tech funds?
(Jason Alden/Bloomberg)

Is it worth staying with technology funds? It is a question few investors can avoid. 

We eagerly consume products and services from tech companies: Amazon, Netflix, Facebook, Google, Microsoft, Apple, and those are just the mega brands – there are plenty more. 

Tech businesses dominate the global stock market. Companies listed on the US tech-focused Nasdaq index have a total value of more than $24tn (£19tn). That is way ahead of the entire UK stock market.

But 2022 has been sobering: Nasdaq is down 26 per cent so far this year.  

Some commentators are comparing the recent pull back in tech to the bursting of the tech bubble in the year 2000. This is a poor comparison. First, the quality of fundamentals is not comparable.

Tech company valuations then were dramatically higher than the recent tech peak in November 2021. In 2000, the average price-to-forward-earnings ratio had reached 113 times. In November 2021 the average was 40 times. 

It is the same pattern for the 20 per cent of the most expensive tech stocks that are trading at a much lower level. That said, even after recent falls there is still a risk that the higher priced tech will fall further.

Market correction

So where are we now in the market correction of tech? The higher interest rate related hit to valuations has now been largely reflected in prices. That said investors should be wary of unprofitable technology companies. 

The reason for this is that in a higher interest rate environment, investors can get a better return on their money in bonds or on deposit. That makes them less willing to fund growth if the prospect of profitability is years away and if the cost of funding future growth is likely to be higher.

What of the impact of inflation on the operations of tech companies themselves? Do they still have the pricing power to put prices up to protect their margins from sticky inflation? The fact is that some do and some, as we are finding out, do not. 

The recent tech earnings season in April painted a very chequered picture. The reason is that year-over-year comparisons were distorted by the strong revenue boost these tech companies enjoyed during the Covid pandemic.

Added to that, this year there have been (hopefully transitory) headwinds from geopolitical discord impacting advertising demand at Meta (owner of Facebook/Instagram) and Alphabet (which owns Google), and supply chain bottlenecks for Apple. 

So given all of this, and with a substantial fall in tech prices behind us, what is the outlook?  

Triggers for positive momentum

Beware, fragilities remain. For things to move back onto a positive momentum the triggers below need to happen.

Post-Covid trends have to normalise. After the Covid-fuelled demand boom came the realisation that this would not continue in more normal times. That meant alarmed investors questioned the durability of growth for certain Covid beneficiaries, and share prices fell sharply.