The tech stock sell-off Thursday did not seem prompted by anything but general risk-aversion. And risk-aversion in the face of sky-high valuations is precisely why the selling can continue.
Thursday, the Nasdaq dropped 4.8% by 2:10 pm EDT, almost halfway to a textbook correction in percentage point terms. The Nasdaq 100, one of the truest representations of the largest, most dominant tech players in the U.S., fell 5%. Apple AAPL fell 6.6%, with Nvidia NVDA down 9%, Tesla TSLA down 8.2%, Microsoft MSFT down 5.8%, Amazon AMZN down 5.3% and Salesforce CRM down 5.9%.
Leading up to Thursday, the Nasdaq 100 had risen 14% since August 11. For the year, the index was up 35% leading into Thursday. Many of these stocks -- semiconductors tethered to the 5G market, software powering at-home needs for people and businesses, e-commerce players and streaming players -- have already had secular growth drivers in place. The pandemic has accelerated those trends. Plus, while the economy has so far had a V-shaped recovery, a new wave of virus infections and the lack of more fiscal stimulus could turn that into a W-shaped one. That drives money into tech stocks, which can power through these headwinds. And on accelerated customer adoption of these growth trends, many analysts and market participants are now fearful that too much demand is being pulled forward for the current valuations to be supported.
The Drivers of the Sell-Off
Investment managers TheStreet has spoken with agree Thursday’s action is hinting at a potential broader rotation into value stocks from growth. With tech up as much as it is for the year, the Vanguard S&P 500 Value etf (VOOV) - Get Vanguard S&P 500 Value ETF Report is down about 9% for 2020. That fund only lost 2% Thursday and until midafternoon, banks and oil were up. And still, by that time, 3 of the 4 major airlines were in the green slightly. For 2020, S&P 500 growth stocks are outperforming their value counterparts by a ratio of almost 2.25, according to economists at Mizuho Securities. That’s the highest ratio since at least 1996, according to Mizuho’s chart and far higher than the ratio of about 1.6 hit in 2000, just before the tech bubble burst.
But that’s just stock price performance.
Most would agree that, in March when stocks across all sectors were sold off indiscriminately out of pure fear, growth tech was sent into an unfair valuation territory. The outperformance of the broader group since then has not been entirely unwarranted. But towards the end of August, as these stocks continued to race higher -- in part due to Apple’s and Tesla’s stock splits, which make the pure dollar value more affordable for small retail investors -- the group of stocks headed into scary territory. "Valuations have been stretched when it comes to Tesla, Google, Apple, etc.,” Marc Pfeffer, chief investment officer at CLS Investments told TheStreet, describing why the selling occurred.
Apple, for one, entered the day trading at roughly 35 times next year’s earnings per share estimate, according to FactSet data. Put that against an expected EPS compound annual growth rate of about 8% for the next few years and the stock’s PEG ratio, or price-to-earnings to earnings growth ratio, was over 4 times. A fully valued PEG ratio is often 2 times, give or take. "Can they [Apple] sustain that 8% CAGR?” Dan Eye, head of asset allocation and equity research for Fort Pitt Capital said to TheStreet Wednesday, just before the sell-off. "Absolutely, but I just would call the valuation fairly optimistic.”
Nvidia, whose data center business is tied to the explosively growing cloud business and whose gaming business is also a leader in the growth category, was trading at around 60 times earnings, while analysts are looking for a normalized EPS CAGR trough 2024 of about 23%.
Why the Sell-Off Can Continue
The losses only give up the last few days of gains, first of all, as the Nasdaq 100 is still up about 8.4% since August 11.
This leaves valuations still high. Apple still trades at 33 times forward earnings. Nvidia still trades at 52 times earnings, not as stretched as some other tech names, as this implies a PEG ratio of about 2.2.
But Tesla still trades at 165 times earnings as of the sell-off, against an expected EPS CAGR of 46% for the next 3 years. That’s a PEG ratio of 3.5.
Pfeffer noted that these types of purely valuation-focused sell-offs can last 4 to 5 days. He poses that, while some market participants may buy this dip on fear of missing out on another momentum rally, there may be some pressure on these stocks ahead, as valuations are re-considered.
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