A “Generational Buying Opportunity” in U.S. Tech Stocks Has Quietly Begun
The relative performance of U.S. technology stocks against the broader market has fallen to its weakest level in 50 years, with the PEG ratio dropping to lows seen between 2003 and 2005; however, earnings expectations remain strong, showing a divergence between stock prices and fundamentals. The ongoing U.S.-Iran conflict may bring economic shocks that limit upward pressure on interest rates, while the technology sector’s cash flow is less sensitive to economic growth. Goldman Sachs believes that a ‘generational buying opportunity’ is emerging.
US technology stocks have experienced their worst relative performance against the broader market in half a century. However, Goldman Sachs believes that resilient earnings and rapidly declining valuations are creating a ‘generational buying opportunity’ for investors.
A team led by Peter Oppenheimer, Goldman Sachs’ Chief Global Equity Strategist, stated that US equities are ‘no longer expensive’ on a relative valuation basis, and after adjustments, a repricing window has emerged within the valuation framework.
Multiple relative valuation indicators have ‘reset,’ with market pessimism toward the technology sector approaching the lows seen in the aftermath of the tech bubble burst between 2003 and 2005. Meanwhile, earnings revisions for the technology sector continue to outpace other industries, widening the divergence between stock performance and fundamentals.
Against the backdrop of investor concerns over the Middle East situation, oil prices, and intraday fluctuations in US stock futures, technology stocks are viewed as a potential defensive allocation. If disturbances in the Strait of Hormuz persist, they could trigger a ‘perceived growth shock’ and limit interest rate increases, thereby enhancing the relative attractiveness of the technology sector.
Weakest Relative Returns in 50 Years; Valuation System Reset
The relative performance of technology stocks against the broader market has fallen to its weakest level in 50 years, with valuations retreating to more comparable levels.
One key change is the return of the PEG ratio between the US and other markets.
After years of decoupling driven by the narrative of ‘American exceptionalism,’ the PEG differential between US stocks and global markets has been reset. The PEG of the technology sector is now lower than that of the global composite market, and the forward-looking earnings prospects implied by the trailing PEG of technology stocks are ‘very weak,’ reaching levels similar to the trough between 2003 and 2005.
In cross-sectional comparisons, the price-to-earnings ratio of the global IT sector has fallen below that of discretionary consumption, essential consumption, and industrial sectors. Moreover, its historical relative valuation premium has also significantly retreated.
Earnings Have Not Weakened, Widening Divergence Between Stock Prices and Fundamentals
The technology sector has not experienced a deterioration in earnings that matches the downward revision in valuations.
Despite market concerns about rising capital expenditures and declining future returns, the return on equity of relevant companies remains high, and earnings revisions for the technology sector are ‘more positive than for any other sector.’
This has led to a ‘record gap between earnings growth and market performance’ in the technology sector.
However, if credit availability suffers a severe shock or the revenue of hyperscale cloud providers is impacted, related investment spending may weaken. Nevertheless, analysts’ expectations for the scale of earnings tailwinds driven by these investments have ‘continued to rise’ over the past few weeks.
Rotation pressures squeeze technology premiums as hyperscale cloud provider valuations approach broader market levels.
Recent pricing pressures are partly attributed to two concerns: market worries about capital expenditures by hyperscale cloud providers and AI-related disruptions impacting certain tech stocks, such as software.
As a result, funds have repriced long-neglected ‘old economy’ companies, including sectors such as energy, basic resources, chemicals, healthcare, and industrials.
These sectors ‘deserve higher valuations,’ but the technology sector has been ‘over-penalized’ despite its continued strong growth. For example, the valuations of hyperscale cloud providers are now close to those of the rest of the S&P 500 components, significantly compressing the premium of the technology sector.
No bubble concerns; Middle East disruptions reinforce ‘defensive attribute’ pricing.
There is ‘no bubble concern’ for technology stocks, as current valuations remain below levels seen before the dot-com bubble of 2000 and the collapse of the ‘Nifty Fifty’ in the 1970s.
Unlike historical bubble phases, the market has not been ‘flooded’ with tech IPOs. Even if new listings emerge in the future, they are more likely to provide a basis for differentiated pricing within the sector.
Geopolitical factors have also been incorporated into the rationale for buying. The Iran war provides ‘the last reason’ to buy tech stocks: the longer disruptions in the Strait of Hormuz persist, the more likely they are to trigger a ‘perceived growth shock,’ thereby limiting upward pressure on interest rates.
The Oppenheimer team stated that given the relatively low sensitivity of the technology sector’s cash flows to economic growth and its potential to benefit from any rebound in government bond yields, the sector may demonstrate greater defensiveness in the coming months.
Editor/Liam
