Despite the recent rout, technology stocks are still not cheap
Since the beginning of 2022, stock markets have sold off sharply, with many major indexes recently reaching bear market territory. Notably, technology stocks, in particular, have borne the brunt of the sell-off (Figure 1, left chart).
With many investors wondering if technology stocks have become attractive again, taking a longer‑term perspective could be instructive. An analysis of stock performance during the pandemic era shows that, despite the steep year‑to‑date sell-off, technology stocks have still returned more than twice as much as the broader market (Figure 1, right chart).
Technology Rout Has Been at the Core of the Sell-Off
(Fig. 1) Pandemic‑era returns for the tech sector still exceed the broader market
December 31, 2021, to June 21, 2022 (left chart) and January 31, 2020, to June 21, 2022 (right chart).Past performance is not a reliable indicator of future performance. Source: MSCI. T. Rowe Price analysis using data from FactSet Research Systems Inc. All rights reserved. See Additional Disclosure.
The earnings for many technology companies surged during the pandemic due to the accelerated adoption of many important technology trends—such as cloud computing, online shopping, and streaming video. While technology stocks gained significantly during this period, their outperformance was partially driven by higher earnings rather than entirely by increases in valuations.
This premise can be tested by comparing the price/earnings (P/E) ratio of the technology sector versus the broader market. As shown in Figure 2, valuations for tech stocks and their valuation premium relative to broader equities became extreme during the pandemic—a “pandemic premium” that has mostly been reversed. Still, it is important to note that the valuation premium for the tech sector remains almost double the 10‑year average premium (Figure 2, right chart).
Have Technology Stocks Become Attractive Again?
(Fig. 2) Sector premium has largely reversed to pre‑pandemic levels but remains elevated
January 2012 to June 2022. Past performance is not a reliable indicator of future performance. Source: MSCI. T. Rowe Price analysis using data from FactSet Research Systems Inc. All rights reserved. See Additional Disclosure.
Overall, the rout in technology stocks has helped to remove much of the froth, and valuations have become more reasonable since their peak in November 2021. However, these stocks are still not cheap relative to the broader market. Given our continued caution toward this heavily growth‑oriented sector, our Asset Allocation Committee recently added to growth stocks but remains underweight relative to value.
Author: Tim Murray is a capital markets analyst in the Multi-Asset division at T. Rowe Price.. To find out more contact your financial adviser.
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