Tech’s Decade of Stock-Market Dominance Ends, For Now

Big technology stocks are in the midst of their biggest rout in more than a decade. Some investors, haunted by the 2000 dot-com bust, are bracing for bigger losses ahead.

The S&P 500’s information-technology sector has dropped 20% in 2022 through Wednesday, its worst start to a year since 2002. Its gap with the broader S&P 500, which is down 14%, is the largest since 2004. The declines have prompted investors to yank a record US$7.6 billion this year from technology-focused mutual and exchange-traded funds through April, according to Morningstar Direct data going back to 1993.

For years, shares of tech companies propelled the stock market higher, pushing major indexes to dozens of records. Excitement for everything from cloud-computing to software and social media drove an epic runup in far-reaching corners of the market. More recently, the Federal Reserve’s accommodative policies at the start of the Covid-19 pandemic fueled a seemingly insatiable appetite for risky bets.

This year, investors are faced with a starkly different environment. Treasury yields have jumped to the highest level since 2018 while bond prices have fallen. Many of the trends that flourished over the past two years—including bullish options trades, special-purpose acquisition companies and cryptocurrencies—have made a sharp U-turn. Only the energy and utilities sectors of the S&P 500 have gained.

Some investors say the decadelong era of tech dominance in markets is coming to an end. Value investors, who buy stocks that are cheap on measures such as earnings or book value, are taking a victory lap after a long-awaited resurgence in shares of companies such as Exxon Mobil Corp., Coca-Cola Co. and Altria Group Inc.

The S&P 500 Value index is outperforming the S&P 500 Growth index—which includes companies such as Tesla Inc., Nvidia Corp. and Meta Platforms Inc.—by 17 percentage points, its widest margin since 2000. Meanwhile, more than US$48 billion has left funds tracking growth stocks, according to data provider EPFR, while investors have poured more than US$13 billion into funds tracking value stocks.

“It is really a change in market regime,” said Chris Covington, head of investments at AJO Vista. “It would be hard for me to believe that you would have the extreme outperformance of growth that you saw in the last five years.”

To many investors, the bets against tech and the monthslong turmoil in the market echo the dot-com bubble of 2000, when the frenzy surrounding companies that later went bust caused losses for investors big and small. Then, the allure of technological innovation combined with low interest rates spurred a rush into Internet stocks. When the bubble burst, the Nasdaq Composite tumbled almost 80% between March 2000 and October 2002.

This year, individual tech stocks have recorded some of their sharpest-ever falls, with hundreds of billions of dollars in market value evaporating—sometimes within hours. In late May, Snap Inc. shares lost 43% in a single session, their largest one-day percentage decline ever and a loss of roughlyUS $16 billion in market value. Once highflying bets such as fintech company Affirm Holdings Inc. and Coinbase Global Inc. have lost more than half of their values in 2022.

The industry’s biggest companies haven’t been spared. Shares of the popular FAANG stocks—Facebook parent Meta Platforms, Amazon.com Inc., Apple Inc., Netflix Inc. and Google parent Alphabet Inc.—have all suffered double-digit percentage declines this year that are steeper than the S&P 500’s.

After the punishing start to the year, many investors are speculating what area of the market will be next to tumble.

“When bubbles break, they don’t just tend to fall to fair value—they have a tendency to go to the other side,” said Ben Inker, co-head of asset allocation at Boston money manager GMO.

Mr. Inker, who has been betting against growth stocks with extended valuations for more than a year, said the extra premium at which growth stocks are trading relative to value stocks is standing above historic levels.

Even after the selloff, technology stocks still make up a near-record 27% of the broad S&P 500, hovering near the highest levels since the dot-com bubble, Bank of America strategists wrote on May 27. The firm cautioned it was too early to buy the dip in many of the stocks.

Of course, some investors point to important differences between the current era and the dot-com bust. Although tech-stock valuations soared in recent years, they haven’t approached the levels seen in March 2000 when forward multiples on the S&P 500 touched 26.2. At their peak in September 2020, the forward price/earnings ratio, based on earnings expectations for the next year, hit 24.08, according to FactSet.

Treasury yields, meanwhile, have risen in recent months, but remain well below historical levels. Today, the 10-year Treasury yield is hovering around 3%. In 2000, it was roughly 5%.

To be sure, it’s early yet in the Fed’s rate-hiking cycle. Investors expect the central bank to keep raising interest rates this year. That means yields will likely keep rising, potentially putting further pressure on tech and other growth stocks. Rising yields make the future cash flows of companies less attractive.

If rates keep rising, “the stock market is going to have to move a good deal lower as well,” Mr. Inker said. “It really does depend on where interest rates are going to wind up.”

Worries about how high and how fast the Fed will raise rates have spurred debate about whether the economy is headed toward a recession, though recent economic data don’t point to one in the near term.

Many investors have been betting against tech stocks or closing out bearish positions. Of the S&P 500’s 11 sectors, tech is on track for the biggest drop in short interest in the second quarter, according to S3 Partners, though it remains the market’s most shorted sector. Traders are still betting heavily against Tesla, Apple, Microsoft Corp. and Amazon, making them among the most shorted stocks, just as they were in each of the previous two years.

Still, some investors and analysts remain confident that tech’s dominance isn’t over just yet.

The ratio of bearish put options to call options on the Technology Select Sector SPDR Fund, or XLK, has been elevated, a contrarian signal that suggests the worst may be over for the sector, according to Jay Kaeppel, an analyst at Sundial Capital Research.

“We discovered that things just don’t go straight up,” said David Eiswert, a portfolio manager at T.Rowe Price. “You can’t just buy a basket of tech stocks. You have to differentiate.” Mr. Eiswert said he thinks some tech stocks, such as Amazon, look attractive after their recent declines and that he may increase his exposure to the group.

The International Monetary Fund (IMF) has described the global economy as “surprisingly resilient” amid rapid interest rate rises to quell high inflation since 2022, post-pandemic supply chain disruptions, a short-term spike in energy prices due to the war in Ukraine and increased geopolitical tensions involving China and the Middle East.

The IMF’s biannual World Economic Outlook report says the world has so far avoided stagflation and recession, with large pandemic savings enabling households to cope with higher rates and inflation, and strong immigration in advanced economies creating unusually tight labour markets.

IMF economic counsellor Pierre-Olivier Gourinchas said most indicators point to a soft landing for the global economy and the IMG now expects “less economic scarring from the pandemic”. He noted that markets had reacted exuberantly in recent weeks to the prospect of central banks lowering interest rates soon.

However, the IMF says global growth will moderate over the next five years to its lowest level in decades. It projects 3.2 percent global growth in 2024 and 2025, the same pace as 2023, with still-high borrowing costs, the withdrawal of fiscal support and weak productivity growth weighing economic activity down.

Australia is expected to underperform other advanced economies, especially the United States, this year but will surge beyond them from 2025. The IMF predicts annual gross domestic product (GDP) growth of 1.5 percent in Australia in 2024, which is well below our long-term pre-pandemic average of 2.5 percent. The US is expected to book above-average growth of 2.7 percent in 2024 and the world’s advanced economies are tipped to average 1.7 percent growth.

Australian economic growth will then move above other advanced economies and maintain upward momentum through til 2029. The IMF predicts 2 percent GDP growth for Australia in 2025 and 2.3 percent in 2029. For the US, the IMF expects 1.9 percent growth in 2025 and 2.1 percent in 2029. For the advanced economies in aggregate, the IMF forecasts 1.8 percent growth in 2025 and 1.7 percent in 2029.

The IMF said higher interest rates had had less effect on the US economy compared to Australia because most US mortgages are on long-term fixed rates and household debt has been lower since the global financial crisis. In Australia, most loans are on variable rates and therefore immediately impacted by every rate rise, household debt is high, and housing supply is restricted.

“The exceptional recent performance of the United States is certainly impressive and a major driver of global growth, but it reflects strong demand factors as well, including a fiscal stance that is out of line with long-term fiscal sustainability,” said Mr Gourinchas.

An example of unusual fiscal policy is the Inflation Reduction Act, which includes US$369 billion in new spending to encourage green energy investment. “This raises short-term risks to the disinflation process, as well as longer-term fiscal and financial stability risks for the global economy since it risks pushing up global funding costs,” he said.

While things are going well now, Mr Gourinchas said risks to global economic progress remain.

“On the downside, new price spikes stemming from geopolitical tensions, including those from the war in Ukraine and the conflict in Gaza and Israel, could, along with persistent core inflation where labour markets are still tight, raise interest rate expectations and reduce asset prices. A divergence in disinflation speeds among major economies could also cause currency movements that put financial sectors under pressure.”

Mr Gourinchas said growth in China could falter, hurting trading partners, without a comprehensive response to its property sector downturn. “Domestic demand will remain lacklustre for some time unless strong measures and reforms address the root cause. Public debt dynamics are also of concern, especially if the property crisis morphs into a local public finance crisis.”

He also noted that weak productivity growth remains a challenge for the whole world and “much hope rests on artificial intelligence delivering strong productivity gains in the medium term”.

Tech’s Decade of Stock-Market Dominance Ends, For Now

Sector’s tumble is worst since 2002; value investors take victory lap.

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