Rising valuations and hefty year-to-date gains for big technology stocks are pushing some investors to diversify away from the sector that has led markets for years.
Tech stocks have soared this year, and their big weighting in the S&P 500 has helped push the index to records with a 25.1-per-cent year-to-date gain in 2021.
Some investors are worried the valuations may have ascended into nosebleed territory. Google parent Alphabet Inc., for instance, trades at a 12-month forward price-to-earnings ratio of 26.6, compared with a valuation of 21.1 for the S&P 500.
Apple Inc. is valued at 26.2 times forward earnings, while the information technology sector, up nearly 28 per cent this year, carries a forward P/E of 26.4.
While gains in big technology stocks have boosted the S&P for more than a decade now, their heavy weighting could sink the index if tech falls out of favour. Microsoft Corp., Apple and Amazon.com Inc., Wall Street’s three most valuable companies, account for close to 15 per cent of the S&P 500′s market capitalization, according to Refinitiv Datastream.
Fund managers in last month’s BoFA Global Research Survey named “long tech” as the market’s most crowded trade and had collectively reduced their “overweight” positions in tech stocks to the lowest level since May. The market’s top four most crowded individual stocks are Microsoft, Apple, Alphabet and Amazon, according to a recent analysis by research firm Bernstein, incorporating factors such as institutional ownership and price momentum.
Limiting exposure to tech stocks over the past decade has tended to hurt portfolio performance over the long run, making investors wary of cutting their holdings too drastically. Still, some are looking to broaden their portfolios to reduce their exposure to the sector’s biggest names.
Garrett Melson, a portfolio strategist at Natixis Investment Managers Solutions, says large technology company stocks may be vulnerable to investors seeking to lock in profits and move some funds to other sectors. Mr. Melson is buying shares in financial and energy companies, which he says will benefit from rising inflation and a strong economic recovery.
“We’re in the camp that the growth rate in the economy is being underappreciated this year and next year,” he said.
Analysts at DataTrek Research say sectors that can benefit from rising growth, including financials and energy companies, are likely to challenge Big Tech stocks into year-end.
“Technology has been a winning group for many years, and we expect it will continue to be so in the future,” they wrote in a Friday report. “But as investors consider where to allocate capital today … we think it likely they will seek out sectors with more exposure to improving economic fundamentals.”
Strong U.S. employment numbers on Friday brightened the economic outlook, as did news of a promising experimental antiviral drug from Pfizer Inc.. Travel stocks benefited, with the S&P 1500 airlines index climbing 7 per cent on the day.
Investors will gain insight into inflation when U.S. consumer price data are released next week.
Denny Fish, a portfolio manager and technology sector lead at Janus Henderson, said inflation concerns and high valuations in the technology sector have prompted him to look for smaller companies that will benefit from growth of giants with more crowded stock positions.
Mr. Fish is bullish on shares of Australian software development company Atlassian Corp PLC, whose product management tools “augment” Microsoft’s suite of applications, as well as Canadian e-commerce company Shopify Inc., which benefits from the growth of Amazon, he said.
“What we’re doing is finding emerging companies that have even better growth than the giant companies and rational valuations that will outperform over multiyear periods,” Mr. Fish said.
Plenty of investors remain bullish on Big Tech-focused stocks, citing their strong earnings and history of dynamic growth.
Saira Malik, chief investment officer for global equities at Nuveen, is looking for tech companies that may benefit from rising inflation and have lagged the broad market rally.
She says she believes shares of Amazon, which has trailed the market with an 8-per-cent gain this year, will be one such “catch-up trade,” powered by growth in e-commerce.
“This is a time to be more selective,” Ms. Malik said.
-- David Randall, Reuters
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