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Is It Time To Enter The Software And Cloud Investing Space After Their Precipitous Declines: Part 1: Investment Considerations.

Courtesy of Bert Hochfeld, Ticker Target

The New Decline: What’s been going on?

More than a few subscribers and some readers on SA: How low is the market going? What should I be doing? How much longer will this bloodletting last? One subscriber wrote to me that he has been nauseous. He asked how to stay calm.

The reality is that I am not calm, but having gone through more than my share of market cycles I know that this one, too, will ultimately fade away. There is a lot of pain now, which I share, and some blood as well, but the world is not ending and tech stocks aren’t about to dry up and blow away. For whatever it is worth, this cycle is very far removed from that of 2000/2001 when most of the companies involved in the internet bubble were really a collection of chimeras. I think I have heard and read most of the bear arguments animating markets. Some of them make sense; most do not. I would like to think I do not have a pollyannish outlook or disposition. And while I have a very positive attitude with regards to the business outlook for the Information Technology (IT) space, I am not a perma-bull and have recommended and implemented trims in my IT holdings on various occasions when valuations have gotten ahead of themselves.

I have broken this article into 2 parts. This first part deals with strategies to think about in dealing with what is self-evidently a bear market in the IT space. The second part will deal with the tactics, i.e. the specific recommendations that I think are the best candidates to take advantage of what I believe to be one of the more significant investment opportunities of the past decade or so in the IT space. Individual names mentioned here are for illustrative purposes.

One way to invest in the space, while mitigating some risk, is to consider making some commitments in the shares of representative ETFs in the space. I am not going to try to suggest which amongst many choices is a “better” or more representative ETF, but the ones I use as a bench mark are the IGV (IGV) which is the iShares Extended Tech/Software Sector ETF and the CLOU (CLOU) which is the Global X Cloud Computing ETF.

This is not one more article that tries to look at interest rates and valuations. I had thought that valuations had compressed enough last fall; that certainly was a mistaken belief. I am well aware of many of the bear arguments with regards to how higher interest rates should negatively impact the valuation of IT names, and find most of them unpersuasive. The fact that interest rates are rising is no new thing; it has been about a year since speculation was first raised about the end of the Fed’s accommodative policies. There was a sector rotation then, for the same reasons as now, and it was fairly brutal with the Cloud ETF (CLOU) falling about 18% in less than 1 month. This implosion has been deeper and of longer duration, with the same index down by 25% in the last 2.5 months. The IGV ETF (IGV), which basically is an extended software/tech ETF that includes some larger IT companies such as Adobe (ADBE), Salesforce (CRM), and Oracle (ORCL) that have lower growth rates, and lower valuations, has seen a fall of 19% over the same period.

Logically, the valuation compression already seen over the past 12 months (more than 50% on average for representative high-growth companies in the IT space based on free cashflow multiples) should have more than compensated for the valuation risks of rising rates. But sentiment, as it always does, speaks louder than logic in terms of the progression of the markets day to day and week to week. And sentiment seems at an almost otherworldly negative peak as I write this on Thursday, 1/13/22.

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