As investors we fight against behavioral biases in every investment decision we make. Our Director of Research Marc Zabicki talked recently about some of these biases in this video. We become attached to our ideas and when we think about selling, “FOMO” kicks in—the fear of missing out. Buying is the easy part. But selling is hard.
After maintaining a positive view of the technology sector for a number of years and seeing it do so well, the LPL Research team faced a difficult decision. Value stocks have been leading, benefiting from the economy opening back up again. More inflation, rising interest rates, and higher commodity prices are generally value-friendly macroeconomic factors. But a more positive view of value stocks should be paired with a less positive view of growth stocks—largely technology.
“It’s tough not to like technology given the strong fundamentals and rapid pace of innovation from many tech companies,” explained LPL Equity Strategist Jeffrey Buchbinder. “But we expect cyclical value sectors like financials, industrials, and materials to fare better the rest of the year as the economy gets a reopening jolt.”
We downgraded our technology view to neutral primarily for these reasons:
1) Reopening. We expect the market’s shift toward reopening beneficiaries and away from stocks best positioned for the work-from-home environment to continue. That means favor cyclical value sectors (financials, industrials, materials, and potentially energy) over the growth sectors including technology as well as consumer discretionary and communication services.
2) Valuations. The price-to-earnings ratio for the technology sector based on estimated earnings over the next 12 months (source: FactSet) is 25—high compared to the sector’s history. The relative valuation—at near a 20% premium to the S&P 500 (25x versus 21x)—is also high as shown in our LPL Chart of the Day. Comparing value to growth based on the Russell 1000 style indexes reveals an even bigger gap—the Growth Index is trading at a more than 60% premium to the Value Index, the most in 20 years. Also consider we expect interest rates to rise over the rest of the year, which could bite into richly valued growth stocks.
3) Neutral relative trend. The sector is near its all-time high and nearly 90% of the stocks within it are above their 200-day moving averages, indicative of a strong trend. But relative performance versus the S&P 500 Index peaked on September 1 and has been drifting sideways to lower since then, as shown in the accompanying chart. The lack of a trend, based on a flat 200-day moving average for relative performance, points to a neutral sector view.
Even though we’ve tempered our enthusiasm, we acknowledge the sector still enjoys solid fundamentals. Demand for technology equipment and software won’t go away just because people get out more. In fact, we wouldn’t be surprised to see the sector grow earnings by 40% during the second quarter on a year-over-year basis (FactSet’s consensus estimate is currently calling for near 30%). But the rest of the S&P 500 companies may see something closer to 70%, including doubling of financials’ and materials’ earnings and tripling of industrials’.
The downgrade to neutral doesn’t mean we plan to head for the hills by any stretch. A neutral view would imply matching the sector’s weighting in the S&P 500 at 27% in applicable strategies. We believe the sector likely moves higher in the second half of the year, along with the broad market, but we just see better opportunities for outperformance in cyclical value stocks.
IMPORTANT DISCLOSURES
This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any economic forecasts set forth may not develop as predicted and are subject to change.
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All index data from Bloomberg.
This Research material was prepared by LPL Financial, LLC.
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