about 2 years ago • 4 mins
US tech stocks have been a solid investment for a long time now, but the ground is finally starting to shift beneath their feet…
✍️ Connecting The Dots
Heading into earnings season, information technology companies’ sales were expected to grow by 15%, and their profits by 11% – below the S&P 500 average. Meanwhile, communications services and consumer discretionary stocks – which nowadays include some companies that investors consider to be tech firms – weren’t expected to fare much better. But earnings season is nothing if not a game of expectations management: companies tend to underpromise and overdeliver, which at least partly explains why the tech giants that have reported results have all beaten expectations.
Higher-than-predicted earnings weren’t enough to keep almost all their stocks from falling, though – partly because of those companies’ future expectations. Netflix, for example, said it’d probably add 2.5 million new subscribers this quarter, compared to the 6 million-plus that analysts were forecasting. And since it's those subscribers who ultimately drive Netflix’s revenue and profit, fewer of them means the company will make less than anticipated. Investors, then, simply won’t pay as much for a share of its (now-lower) future income, which led some of them to ditch its stock. Then again, others would’ve taken Netflix’s update with a grain of salt: the underpromise-and-overdeliver dynamic is at play here too, so the streaming giant is likely to outperform its forecast and send its shares higher in the long run.
But there’s an even bigger reason for tech stocks’ poor start to the year: the US Federal Reserve is well on the way to reducing its bond-buying support for the economy and increasing interest rates later this year. And that hurts tech companies – particularly those which don’t actually make very much money (if any at all). After all, low or no profit is all well and good when investors can’t get much of a return from safer bets like government bonds. But when higher rates push those returns up, tech firms’ promise of “jam tomorrow” becomes a lot less appealing.
1. Here’s where to invest when rates are rising.
The Fed has been on eight “hiking cycles” since 1975, and the way stocks have responded to them each time gives clues about what will happen this year. Value stocks – companies whose shares look cheap versus profit forecasts – have historically been a good bet, so buying European stocks over US ones could make sense. And if they can successfully pass higher costs onto consumers via higher prices, they could see both their profits jump and their stock prices shoot up in reflection of their now-higher earnings profile. Growth-focused tech stocks, meanwhile, rarely fit the bill in that regard.
2. Tech giants could still hold up.
Not all tech companies are created equal: unprofitable tech stocks might be out of favor, but analysts expect the “megacaps” like Apple, Amazon, and Google-parent Alphabet to do much better. That’s partly because they’re highly profitable, but also because they have inflation-proof “pricing power”. In other words, their services are so important to their customers that they can hike prices without losing many of them. There’s one big clue that reveals a company with pricing power: their “gross margin” expansion and stability, both over time and during previous high-inflation periods.
🎯 Also On Our Radar
Tensions between Russia and Ukraine don’t seem to have had much of an impact on financial markets yet, but the potential impacts on energy and trade could quickly send things spiraling. And with Italian bank Unicredit announcing last week that it’d be pulling out of a takeover of a Russian bank due to the Eastern European conflict, investors might be on high alert for further-reaching effects than they thought.
Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.