The U.S. technology sector was raging in their rally until Friday – when investors decided to pull the brakes. So, is the party over for tech stocks, or is this just an inevitable correction?
As the best performing sector in the S&P 500 this year, U.S. Technology stocks have quickly become fund managers’ darlings. According to the Bank of America, active funds were 71% overweight in FANG as of end-May (as reported by Bloomberg). Silicon Valley’s top players and their rapid innovations catapulted their stock prices to record highs in recent weeks. But Friday’s abrupt pullback followed by extended losses on Monday begs the question of whether their love for tech stocks has become too hot for investors to handle?
Until Friday, the S&P 500 Information Technology increased around+22% since the start of the year – largely driven by Silicon Valley’s elite which includes Facebook Inc., Amazon.com Inc., Netflix Inc., Google’s parent Alphabet Inc. (together called FANG) and Apple Inc. It is not hard to figure out why investors had been splurging on the top tech behemoths. Facebook and Google are ruling the global advertising market; Amazon is dominating the e-commerce boom and cloud services; Netflix is disrupting the TV viewing experience globally; and Apple’s clout in the pricier phone segment does not seem to fade. Many of these tech-giants are also rapidly foraying into new territories, thereby potentially adding to their future prospects and heated valuations.
But since late last week, investors let go of some of the heat. On Friday, Facebook, Alphabet and Amazon each lost more than -3% in share prices, while Apple’s stock declined almost -4%. Netflix’s had the sharpest plunge at -4.7%. The overall Information Technology (in S&P 500) declined close to -3%. Downward pulls continued through Monday. Are investors getting spooked of the possibility of overheated valuations?
It is too soon to suggest that this is the beginning of the end for tech’s rally. Some of the biggest players in the sector had solid earnings and revenues growth in recent quarters that are hard to ignore – something that should ease worries of a prolonged rout. The recent break in momentum could only be a correction, potentially reining in possibilities of unsustainable valuations and their subsequent collapses.
Momentum and subsequent corrections are inherent dynamics of financial markets, and the tech sector is no exception. Therefore, it is important for investors to build well-diversified portfolios that can also work around market uncertainties. This is where active funds may have a distinct edge over passive ones. Once they are invested in a fund tracking an index, passive investors will have to accept the returns of the overall index – even if that means foregoing potentially higher returns from an outperforming sector, and having limited flexibility in cushioning downside risks within the index. An active manager can decide to overweight tech or emphasize it in a different way than the index, in order to potentially boost returns on the upside but also to potentially mitigate downside risk if a sector or region is expected to underperform. It is here that the flexibility of an active approach can help an investor create alpha in their investment portfolio. At the same time, through its portfolio rebalancing strategies, active management can potentially help an investor stay disciplined in their long-term investing goals. This protects investors from getting carried away by momentum or volatility.
Bottom Line for Investors
The recent sell-off does not necessarily portend a sustained trend reversal in tech stock prices, but it sure exposes the dangers of trying to time the markets. Getting swayed by mere momentum could lead you to buy high and sell low – thereby eroding your portfolio’s return potential. Ultimately, a security’s long-term returns will be guided by fundamentals versus speculation. That’s why, it is so crucial for investors to be cautious of overexposure to market momentum. And, that’s something active management can help you gain control over. Sure, technology stocks could offer portfolio opportunities given the sector’s rapidly expanding footprint in consumer and business markets, but that should not drive you to forego diversification in your portfolio – the recent break in tech rally should be proof enough.
At Zacks Investment Management, we help our clients leverage opportunities from sectors for growing their nest eggs, without getting carried away by mere momentum. That’s why, we place emphasis on fundamentals. Using our own databases, software and completely unbiased research on sectors and companies, we offer allocation and diversification strategies custom-made for every client’s individual goals and risk appetite. To get a sneak peek into these strategies, check out our Dean’s List of Investment Strategies. Here’s the link to download your free copy:
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