Will the tech sector bull market finally run out of steam in 2022?

by Jonathan Adams

A little over a week into 2022 we’ve already experienced some major market movements. On Wednesday, January 5, the Nasdaq dropped 3.3% for its worst day in almost a year as investors offloaded shares of the technology companies that their valuations soar over the pandemic.

Still unprofitable tech companies, many of whom only listed in 2021, were hit hardest. U.S. Treasury yields are climbing and the Fed is expected to hike interest rate by up to four times this year to curb inflation. That’s all increasing the price of risk in a way that has already injected volatility into 2022’s financial markets just days into the new year.

The major factors to influence economic and financial market trends in 2021 are mainly expected to continue to play a role this year. There will undoubtedly be new developments not yet on the radar that will also have an impact. But Covid-19 disruption and the pandemic’s influence on consumer behaviour, inflation, interest rates, a tight labour market and supply chain issues will all still influence whole sectors and individual companies.

One of the biggest questions for investors setting their initial strategy for 2022 is if the long-running tech sector bull market can be maintained for another year.

Teck stocks – might the engine of growth start to splutter in 2022?

The tech sector, broadly defined as any company whose business model relies on technological innovation, has been the engine of growth for the international stock market over the past decade and some. Especially Big Tech has contributed the lion’s share of the long equities bull market that has been in place for thirteen years; if we discount the short, sharp sell-off that technically interrupted it in early 2020 as the coronavirus pandemic hit.

Big Tech valuations look stretched if growth rates can’t be maintained

But valuations have long looked stretched. In the case of the highly profitable and established tech companies like Microsoft and the FAANG stocks, current valuations are a big bet on future revenue growth. Anything that casts doubt on that could spell trouble for investors heavily exposed to Big Tech.

A drop off in growth could come if consumers reallocate spending to physical experiences like socialising and travel in a post-pandemic world. Pent-up demand for interaction with the non-digital world after almost 2 years of restrictions increasing digital consumption could swing the pendulum the other way.

It’s hard to predict if, collectively, society will continue to spend more on gadgets, digital products and through ecommerce retailers. It may now be an ingrained habit that sees the trend continue even if it weakens slightly as we, hopefully, come out of the pandemic. But there is always the chance of a more dramatic shift of the pendulum back towards spending on physical experiences and activities we’ve hungered for during pandemic restrictions.

But even in the positive scenario for profitable tech companies, that their revenues continue to grow, preventing the rate of that growth dropping compared to the past two years will be a challenge. Many ecommerce companies saw their valuations fall last year after still impressive growth rates couldn’t match expectations heightened the previous year.

Next year will almost certainly see growth rates drop back towards more normal levels. Ecommerce growth reached 38% in the fourth quarter of 2021 but is expected to only just make double digits this year. It’s hard to tell how much current valuations are pricing that in already and how much they might be hit when it becomes a reality.

Spec Tech’ has had a difficult start to 2022 and could face a tough year

In 2021, a huge amount of equity capital was raised by tech start-ups yet to reach profitability. Hundreds of companies came to market via reverse mergers with special purpose acquisition companies, known as SPACs, at valuations in the billions despite often still making heavy losses.

Some even have no revenues or even a completed product. In November, after a 67% gain from its IPO price, the valuation of electric pick-up truck start-up Rivian came within 25% of Volkswagen, one of the world’s largest producers of vehicles. Rivian still hasn’t delivered a truck to a customer. Its valuation has more than halved since but Rivian is still worth over $77 billion.

Another EV start-up, Lucid, listed via a Spac in July and saw its share price increase by around 350% to the end of November. It has also shed almost 25% of its valuation since. But is still worth $69 billion despite having manufactured around 500 vehicles by the end of 2021.

And, of course, while Tesla has undoubtedly proven many of its doubters wrong over the years and continues to do so, its over $1 trillion valuation is hard to justify by any traditional metric. It trades at a P/E ratio of over 333, despite an early year share price slide.

But hundreds of companies that are yet to make a profit, generate revenue, or even be very close to either, went public at hefty valuations last year. It isn’t hard to see a scenario where rising interest rates increasing the price of risk hits newly listed ‘spec tech’, as the more speculative technology bets have been dubbed.

The chart below, published in the Financial Times, shows the extent of the first week plunge for non-profitable public tech companies:

investors

Goldman Sach’s index of non-profitable tech stocks is down 9.8% for the year compared to 1 1.2% loss for the S&P 500.

Who are investors betting on instead?

Money that has flowed out of the tech and especially non-profitable sector in early 2022 has been reallocated to banks, industrial and energy companies as well as traditional carmakers. While the Tesla share price is down 14.4% for 2022, Ford and General Motors are up 12.26% and 1.8% respectively.

The big long term trends still look good for the tech sector.

Stock market analysts have been saying the tech sector is overvalued for years and the market has just kept climbing. Might 2022 be the year gravity catches up with the tech sector? I wouldn’t discount it and it’s something investors heavily exposed to the tech sector should keep a close eye on.

But even if 2022 does see a tech sector correction, the underlying secular trends in tech’s favour look as strong as ever. The pandemic has reinforced businesses’ understanding of the need for digital transformation to increase business flexibility. Cloud computing has grown rapidly over the past decade but has only started to claim market share for the most established IT workloads. And despite rapid gains over the past two years, ecommerce still only accounts for around 15% of retail spending in the US (though it’s now over 30% in the UK).

All of this leaves plenty of room for longer-term tech sector growth. But after recent gains and with the immediate outlook looking less certain, another year of gains for tech stocks looks far from certain and a correction not unlikely.



Important
This article is for information purposes only.
Please remember that financial investments may rise or fall and past performance does not guarantee future performance in respect of income or capital growth; you may not get back the amount you invested.
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