Welcome to RBC’s Markets in Motion podcast, recorded May 19th, 2021. I’m Lori Calvasina, Head of US Equity Strategy at RBC Capital Markets. Please listen to the end of this podcast for important disclaimers.
This week in the podcast we take a deep dive into Tech, the worst performing sector in the S&P 500 year to date, which has continued to lag since late April. The key thing you need to know: we reiterate our view that the pain in big Tech likely isn’t done yet.
If you’d like to hear more, here’s another five minutes. While you’re waiting, a quick reminder that you can subscribe to this podcast on Apple, Spotify, and other major podcast providers. If you like the podcast, please rate and review it to help other listeners find the show.
Now, the details.
There are five reasons why we think the pain in big Tech isn’t done yet.
First, Tech’s positioning problem hasn’t been fixed. Nasdaq positioning by asset managers remains well above past lows in the futures market. This indicator, where we get a weekly update, is off its peaks, but doesn’t look washed out either. On a dollar value basis, the latest readings are still well above the lows seen in 2009 and 2018. The net short readings seen in this indicator earlier this year back in March also failed to return to those lows.
Second, TIMT valuations – while improved – are still expensive vs. history and aren’t compelling yet vs. the broader market. TIMT is how we look at the broader big Tech space, it includes Technology, Internet, Media and Telecom. As of mid-May 2021, the weighted median P/E for TIMT was still at 25.2x, well above it’s long-term average of 18.4x as well as its post Tech bubble average of 16.8x.
Relative to the S&P 500, TIMT valuations have improved but still aren’t compelling. As of mid May, the market cap weighted relative P/E for TIMT was very slightly below its long term average, but still a bit above its post-Tech bubble average. Eventually, attractive valuations seem likely to bring buyers back to the TIMT space given solid fundamentals, but that condition simply hasn’t materialized yet.
Beyond TIMT valuations, we are also keeping a close eye on the valuations of Banks relative to Software, two critical pieces of the Financials and Tech sectors. Our analysis here makes an even stronger case against Tech as Banks valuations still look deeply compelling relative to Software.
It’s worth noting that Banks/Software relative performance also tends to track the yield curve – where steepening and an improving economy are also making the case for cyclicals like Banks at the expense of defensive secular growers like Software.
Third, this is a bad macro backdrop for Tech. TIMT broadly, and Tech specifically, tend to underperform when inflation expectations are rising. It’s not that inflation itself is terrible for the big Tech space. Rather, Tech is the source of funding for the rotation into areas of the market that benefit more directly from an improving economy, higher bond yields, and inflation itself – areas like Financials, Materials and Energy. And while Tech also benefits from an improving economy, it’s not the only one that’s true for. The key thing to understand is that Tech’s strong fundamentals just aren’t that special and unique anymore.
Fourth, Tech earnings momentum looks like it’s topping out. The rate of upward eps estimate revisions for TIMT is strong, with far more upward than downward revisions. But this gauge of earnings sentiment is back to past highs and likely to fall soon.
Finally, ETF flows to Tech have dried up. Tech ETF flows surged from 2015 to 2020, helping to fuel explosive performance in the sector. But these inflows have vanished as we’ve started to see strong inflows into value and cylical oriented sectors like Financials and Energy.
In closing, it’s worth noting that what we see in Tech and TIMT echoes our work on Growth vs Value. The style rotation that’s been underway in the US equity market – out of Growth and into Value – has been one of the most popular topics of conversations in our recent meetings with investors. We’ve been in the Value camp, due to stronger EPS estimate revisions trends (last seen in 2016), better valuations (which have improved for Growth but are still elevated vs. Value), better flows (quite strong in Value, less so in Growth), and a favorable economic backdrop (real GDP is expected to sustain above trend growth through 2022, and historically Value beats Growth when that occurs). Tech is simply on the wrong side of this transition. As we said earlier, it’s not that things in Tech are bad. It’s just that Tech isn’t all that special and unique anymore.
That’s all for now. Thanks for listening. And please reach out to your RBC representative with any questions.