Why the red-hot tech trade may crumble: Morning Brief

Why the red-hot tech trade may crumble: Morning Brief

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It’s been a crazy year for markets up to May, but at the same time a throwback boom year for investors in tech land. Which could be nearing a pause.

Year-to-date the Nasdaq Composite (^IXIC) is up 18%, dusting the S&P 500’s (^GSPC) 8% gain and the Dow’s (^DJI) 1%.

Most of the Nasdaq’s advance could be attributed to speculative triple-digit percentage moves in biotech stocks. But there have been a host of big moves in well-known names: Tesla is 40% on the year, Roku has clawed back 39% and Booking Holdings is up 32%.

Market pros tell me the relative out-performance for tech stocks reflects two things.

First, tech companies from chip giant Intel to social media leader Meta have slashed expenses. The lift to profits from those deep expenses cuts began to appear in the first quarter and could look tastier in the second quarter.

And two, the expectation of a Fed rate hike pause has fueled a renewed interest in the tech trade. Tech investors foam at the mouth at the idea of lower rates, and after a long series of hikes, simply not hiking has the same effect. This has proven time and time again as a key driver of tech valuation multiples.

The problem is that the good times in tech stocks could be approaching some form of pause just like the rate hikes.

For starters, there are numerous economic risks mounting from real concerns on a recession, a U.S. debt default, and a Fed that may not yet be done raising rates (see Fed governor Bowman’s comments last Friday, as reported by Yahoo! Finance’s Jenn Schonberger).

As a result of these macro risks, the valuations on many tech stocks look extended. I think JP Morgan strategist Mislav Matejka nailed this vibe in a new client note.

“Our call is that bond yields will be down further from here, but [the] tech bounce appears to have over-discounted that now. In addition, the clear and rising risk is that the Fed does not deliver on market expectations for cuts in second half of the year. Real rates could stay higher, with tech inversely correlated to them,” Matejka said. “With respect to the earnings outlook, consensus expectations are for the technology sector to expand its profit margins by as much as 140 basis points next year, the largest increase of all sectors, and which would put it at new all-time highs. We see risks to this, especially if the economy weakens into a downturn.”

Bank of America’s Michael Hartnett said on Friday in a note the tech trade could “crack” in large part due to a more hawkish Fed.

So there is all of that.

And the component here is that tech looks done with the profit-boosting expenses cuts.

I have been out and about lately talking with top tech leaders and the feeling is all the low-hanging fruit on expense savings has been picked. A lot of companies that cut deep in 2022 to appease Wall Street are back to spending again (though not at the same pace as in pre-2022’s reset), notably in the AI space, which also appeases Wall Street.

So investors banking on epic profits from tech in the second half of the year due to new expense savings may be let down.

Bottom line: respect the tech trade, but realize nothing good lasts forever.

Brian Sozzi is Yahoo Finance’s Executive Editor. Follow Sozzi on Twitter @BrianSozzi and on LinkedIn. Tips on deals, mergers, activist situations or anything else? Email [email protected]

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