Despite a rally of nearly a sixth since June, the NASDAQ Composite index is still trading more than 20% below its late November 2021 all-time high.
That means the index is still in what is technically known as a bear market – although bulls of tech stocks will point out that the NASDAQ has still doubled over the last five years.
The NASDAQ peaked nine months ago and another good proxy for tech stocks, the Philadelphia Semiconductor Index, or the SOX, is down by a quarter from its December 2021 all-time high.
There has been much greater carnage in some of the more speculative areas of the tech stock market, where some of the SPAC deals, electric vehicle listings and others have seen share price collapses of 90% and more.
What has caused this?
First, in many cases, valuations became very stretched, especially during the pandemic, as fiscal and monetary stimulus intended for the economy gushed into financial assets.
Second, those lofty valuations proved impossible to sustain after the pandemic, as the effects upon the real economy of fiscal and monetary stimulus wore off, demand slowed, and supply chains remained clogged.
Many tech stocks had business models that were perfectly adapted to the pandemic, as their products and services kept us fed and watered, entertained and in touch, but the growth rates seen during the viral outbreak have been difficult to sustain after it.
Profits have started to disappoint, even at firms like Netflix, Amazon, Meta and Apple.
Finally, the combination of rising inflation and rising interest rates is not usually a good one for perceived growth stocks like technology names.
Investors latch on to technology stocks for the long-term growth prospects, and any firm capable of generating sustained growth in a low-interest-rate, low-growth, low-inflation environment will be highly prized, and investors will pay premium valuations for them.
However, rising inflation means that growth is easier to find, at least on a nominal basis, so investors stopped paying high prices for long-term growth – jam tomorrow – and switched to downtrodden, much cheaper, cyclical stocks that, in an inflationary economic recovery – could offer jam today.
That’s why tech stocks started to fall out of favor almost two years ago as financial markets did a much better job of sniffing out inflation than central banks.
Global market reaction
Hopes for a peak in inflation – and a peak in central bank interest rates in 2023 – are stoking a recovery in tech stocks.
If inflation does cool and rates are cut in 2023 that could help forge a sustained tech recovery, but in some cases, valuations are still high and earnings are still disappointing so it could be a bumpy ride.
Some will even argue that the summer rally is no more than a classic bear market trap, a surge that will catch out the unwary and lure them into suffering further investment losses if they try to chase it.
New generations
After the tech, media, and telecoms bubble burst in 2000, it took the NASDAQ more than a decade to recapture the ground that it lost after its collapse.
The bigger the party, the bigger the hangover. But new generations of tech stocks will emerge and render current winners obsolete, so the landscape will always keep changing.
As will the identity of the new generations of leaders – although that is one reason why investors should always keep an eye on the valuation they are paying for tech names, because they tend to assume that current winners will stay winners for ever, and the history of tech suggests that this is very rarely, if ever, the case.
Russ Mould is investment director at AJ Bell.
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