Why Tech Stocks Are Doing Especially Poorly During the Market Selloff
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Technology stocks like Amazon and Netflix had a stellar run during the pandemic, pumped up by stimulus money and higher demand driven by lockdowns. But 2022 so far has not been good to the tech sector.
The tech-heavy Nasdaq Composite is down around 23% for the year so far, after soaring 21% in 2021. For the sake of comparison, the S&P 500 — an index made up of 500 of the largest U.S. companies from a wide variety of sectors — has fallen 13% this year.
Even after stocks overall bounced back last week, technology giants like Netflix and Meta are down around 67% and 42% for the year, respectively, while popular "at-home" tech companies like Zoom and Peloton are down around 40% and 59%. Even shares of Apple and Google's parent company Alphabet have fallen more than 20% so far in 2022.
Tech "took it on the chin," says Liz Young, head of investment strategy at the digital personal finance company SoFi. "And it may continue to take it on the chin because we don't seem to be coming out of this environment anytime soon."
Here's why technology stocks have been pummeled amid the broader stock market selloff in recent weeks.
Fed interest rate hikes
During the pandemic, the U.S. central bank kept interest rates near zero and stimulated financial markets via quantitative easing — a policy which entails the Federal Reserve buying financial assets to boost economic activity.
We watched as the stock market hit record high after record high, and investors cheered as they made money with relative ease by investing in riskier assets like tech stocks, and even meme stocks and cryptocurrency.
Now, that era of easy money is over. The Fed has already raised its benchmark interest rate twice in an effort to tamp down inflation, and it has outlined a plan to reduce its massive balance sheet. Stocks have suffered as a result.
"Tech stocks are higher risks," says Jay Hatfield, CEO of Infrastructure Capital Management. "So when the stock market's going down, they're going to go down more."
'Math has changed' for tech stocks
When experts determine a stock's value, they don't just look at how much each share costs. An important factor they consider is the price-to-earnings ratio — essentially, the price a stock is trading at versus how much money the company is actually earning.
Tech stocks are higher growth stocks and typically have a higher price-to-earnings ratio, says Matthew Bartolini, head of SPDR Americas research at State Street Global Advisors.
The expectation for many tech stocks is that buying them will potentially pay off in the future because of that higher growth potential. Yet interest rates have gone up, which tends to constrain businesses and consumers' abilities to borrow and spend.
Now, when experts are looking at valuations and discounting future cash flows back to a present value, the higher discount rate is going to lead to lower valuations, Bartolini says.
"The math has changed in terms of the way a firm is being valued," he adds.
With many Americans stuck at home for the last several years, there was a huge demand for many of the products and services from these technology companies. As Eric Diton, president and managing director at The Wealth Alliance, recently told Money, you couldn't have a better business than Amazon when people all over the world wanted to stay home for their health and avoid venturing out to stores.
The surge in demand for tech products like laptops and the boom in online shopping helped pump up the stock prices of the companies providing these goods and services.
"It’s a liquidity and pandemic-driven bubble," Hatfield says.
But the world looks a lot different now than it did in 2020. People are traveling, dining out and working in the office again. Peloton, the at-home workout company that garnered a ton of success during the pandemic, for example, lost $757 million in the first three months of 2022 and unveiled plans earlier this year to lay off 2,800 employees. (Peloton did not respond to Money's request for comment.).
Shift in investor demographics
Tons of new investors entered the stock market during the pandemic. They included high school and college students teaming up to swap trading tips between classes, as well as people stuck at home turning to social media to learn about investing with their stimulus checks. Many of these first-time investors were fairly young, Young says.
"This generation is just naturally more interested in technology stocks," she adds. "They're more technologically advanced than prior generations were at that age, so it's what they're comfortable with and it's what they know."
But now that the economic environment is putting pressure on those stocks, it's been difficult for investors — especially newer ones — to see past it and understand the value in holding tech stocks into the future, Young says. New investors may not have had money in the market long enough to see a significant downturn.
Tech stocks also have significant exposure to the effects of COVID-19 lockdowns in China. The country has maintained "zero COVID" policies throughout the pandemic to limit the spread of the virus via strict lockdowns, testing and restrictions. But there are concerns about the impact of these policies on China's economy.
While some companies outside of the tech industry are suffering from these lockdowns because Southeast Asia is an important factor in their sourcing and supply chain, tech companies are getting hit especially hard because many of the people buying their products are also in that part of the world, says Shawn Cruz, head trading strategist, TD Ameritrade.
"Some of these tech companies are getting absolutely clobbered on both sides of the coin," Cruz says.
Is this a buying opportunity for tech stocks?
When stock prices are struggling, there's an opportunity to get a deal on stocks you might have had your eye on in the past.
But it's key to focus on profitability, Bartolini says. Within the tech sector, there are companies that have had their valuations decrease but are still profitable overall, like Apple and Microsoft. When you get into some of the more small and mid-cap stocks, however, there are plenty of companies that aren't profitable like virtual healthcare services company Teladoc and online trading platform Robinhood.
If you buy a stock low just because it's low, things can get dicey. The risk is that you might buy the stock before it hits bottom and there's more pain ahead, Bartolini says.
If you buy a stock and it then falls 10%, you're going to need an 11% gain on the way back just to break even. Of course, there's no guarantee that any individual stock will get back to its 2021 high. Some dot-com era favorites, like Pets.com, didn't survive the bubble bursting.
Once you zero in on what you want to buy, don't spend all your money in one day, Young says.
Instead, use a method like dollar-cost averaging, which entails investing a modest amount of money at regular intervals instead of trying to buy the dip all at once. For example, if you have $10,000 to invest, you can invest $1,000 every other Monday.
That way, you maintain a disciplined approach and minimize risk, while ensuring you'll benefit from a recovery.
"Technology is still the future of the American economy," Young says. "It's something that may take a little while to show its shine again, but this is not a forever situation."
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