Are Tech Stocks More Dangerous to Hold Right Now?

Toni Sacconaghi

A major analyst in the tech sector is now warning us to be wary of tech stocks during the next quarter at least. It’s always wise to be more cautious with this type of stock though.

Bernstein’s Toni Sacconaghi is one of the most followed analysts in the tech sector, and he follows some of the biggest names in the business, including Apple, IBM, and Intel, as well as Tesla, although that’s only sort of a technology company.

When he speaks, people do listen, although the process of stock analysis is far from an exact science the quality of one’s work really comes down to how well one takes all factors into account and comes up with guidance that can be relied upon.

Many analysts are concerned about this quarter’s earnings results, and the consensus is that we’re in for a rough ride at least nominally, meaning the actual results and not necessarily how well these results meet current expectations.

Any meaningful discussion of earnings reports does need to take into account that this is really about how well a company does versus how we think that they are doing, although this does not mean that info along the way won’t matter, and this does move markets as well.

Along the way though, it is changing expectations that drive things, and this does change from time to time and we price in these changes as they become known. These changes might even involve someone’s guess, particularly if the guess is made by the company, who are at least assumed to know more about these matters than anyone.

We already know, for instance, that we will likely be seeing a disappointing earnings season this time around, and therefore this outlook is already priced into stocks. When we look at where the market is right now, we can also surmise that this potential grim news is not bothering the market right now, and it is only if and when the actual story is a worse one than we expected that we need to be concerned about any of this.

Sacconaghi does see this sort of disappointment on the horizon though, with tech companies that is, and since we are in an economic downturn of sorts, and tech stocks are more subject to these changes, it is not unreasonable to think that they would suffer more during these times.

Sacconaghi does see these numbers coming in worse than expected, and we know that it is not nice to disappoint the market, especially with volatile stocks like these that can move down faster than your average stock as well as move up faster.

Tech Stocks Have Higher Valuations Because People Don’t Mind Paying More for Them

He’s also concerned about valuations with these stocks, although when stocks go up in price quite a bit, and are also as popular among investors and traders as these stocks are, people will bid them up more and we may therefore expect higher than average valuations with them, which is the ratio of their stock price to their earnings.

Some people become concerned with higher valuations though and this can have both investors and institutions selling stocks when they get too uncomfortable with these numbers, so it’s not that this stuff doesn’t matter.

Stock prices are always a battle between the bears and the bulls though, with the bears in this case worrying about these ratios being too high, and the bulls not caring about such things and along for either the shorter-term ride that a stock is on or are expecting larger returns long-term from these stocks.

In a real sense, a stock’s price and not external factors to the market or anything else is what determines where the real equilibrium is, and as things change, we see things like price-to-earnings ratios change accordingly. If, therefore, the average multiple of 21.5 that concerns Sacconaghi was felt to be too high by the market, the market would speak and lower them by lowering the stock’s price.

Whatever the ratio we see for a stock, we can therefore say that this is where the equilibrium is, whether that be 10 with stocks that people don’t like or 25 with ones they really like. Aside from the fact that a stock’s price looks further afield than just a company’s current projected earnings, to the extent that concerns about multiples limit a stock’s price potential or otherwise influence its price in any way, the current multiple, no matter what it may be, is fully accounted for in a stock’s current price.

When earnings actually decline, this does in itself put a stock’s multiple up, with no corresponding change in price that is, and we often see a stock’s price decline when earnings actually decline, and we then find a new price equilibrium, which is at a lower one depending on how much this bothered us.

When we speak of companies earning money, this does involve the growth of a company, even though the level of growth may have gone down. The company’s value therefore increases, and we would therefore expect that, over time its share value would increase as well.

We can’t really say that a higher ratio is bad and this is actually essentially a neutral thing, all dependent upon market perception.

A stock can have a higher ratio just because it has more promise for the future, and we even have stocks go up when they have a negative ratio, when it’s their price to losses. Paying too much attention to these things can often leave us seeing the situation on a shorter time frame than a lot of market participants do, as this really limits us to one year out at most with anything beyond that completely left out of the equation.

We Do Need to Pay More Attention Now Though

When people see a disappointing earnings result, they aren’t thinking about this ratio, they are just reacting to the disappointment itself, but that can be plenty enough to send a stock reeling if the news is bad enough. We see this quite often in fact.

This is the reason why Sacconaghi may be right in telling us to be more cautious with tech stocks during the next while, and tech stocks already should be treated with more caution anyway. When you get a market pullback, or disappointing news about either the economy, the sector, or the stock, or even political issues such as tariffs or threat of more regulation, these stocks can really take it on the chin.

In the long run though, at a time where quarterly earnings reports themselves become a blur, tech stocks have done fabulously, and there isn’t a good reason to think or be afraid that this won’t continue, and this appeal will continue to help these tech stocks maintain their higher valuations overall save for a real bear market.

What happens with stocks that are more volatile like tech stocks is that they start out with higher valuations, and during bear markets, these valuations decline more than normal stocks do. A stock with a higher valuation therefore can be more dangerous to hold during bear markets, but to put this tip to use we need both a high valuation and a bear market, and we are missing the bear market part right now.

When we did get the little bear market of late 2018, tech stocks took more of a beating and some lost 40% or more, in comparison to the 20% average. They do come back faster generally once things turn around, and this is why a long-term investor may not be bothered by this as the long-term trend is upward, but these are also stocks that we can benefit the most with as far as looking to time them and be out during some of these moves down.

With the real potential for disappointment coming up, which may or may not come to pass, and particularly with the chance that tariffs may be having more of an impact than we think, it does pay to be on guard if you own tech stocks and you are at least open to getting out of these positions or cutting them back should things move the wrong way enough.

For those who want to manage their risk more, and just want to steer clear of these stocks until the dust settles more and there is not so much concern out there about them, that may not be a terrible choice.

Anyone looking to part with stocks on the basis of an earnings report isn’t even an investor though, or not purely one at least, they are part trader really, as this is the sort of thing that traders do, and defines traders actually. Traders trade on timeframes that earnings reports matter, and investors do not, at least by definition anyway.

Sometimes investors can want to become a one-off trader though and do something only a trader would do if they are feeling stressed about their positions, but if they do want to play this game they need to remember that we first need to wait for a real reason to sell and also be prepared to get right back in when the situation warrants.

Otherwise, we’ll be using a mixed strategy and this is not something we want to mix and match. We may get out but if we have no idea when to get back in, and we are indeed investing for the long-term, we will tend to re-enter at a higher price if we do get back in, and when we don’t, we have given up all of the positive returns to come, the ones we bought the stock in the first place to capture.

Most investors could benefit from looking to time their investments better, but this involves looking to sidestep the actual big stuff and the bigger trends and we’re not seeing anything of the sort just yet, although this all does bear watching carefully.

Monica

Editor, MarketReview.com

Monica uses a balanced approach to investment analysis, ensuring that we looking at the right things and not confined to a single and limiting theory which can lead us astray.