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US technology selloff a small cap affair: Charts of the week

Lewis Jackson  |  17 Jan 2022Text size  Decrease  Increase  |  
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US markets are off to a rocky start as investors abandon the once-high flying technology sector. New York’s Nasdaq Composite is down 6% this year as investors revaluate technology bets amid strong signals from the US Federal Reserve that interest rates could rise as soon as March. But in today’s Charts of the Week we find reason for cheer: the worst of the stock market rout remains confined to smaller-cap US technology stocks.

Looking at the Morningstar’s US technology index there are reasons for investor pain. A fifth of the stocks in the Morningstar US Technology and Communication Services Index are down more than 50% from their 52-week highs. Forty per cent are down more than 30%.

But the biggest losses so far are largely contained to smaller companies. Those down more than 50% have an average market capitalisation of $10 billion versus $52 billion across the index. Stocks caught up in the turmoil also tend to be minor parts of the index, with an average weighting of 0.05%. By comparison, Apple and Microsoft together make up a third of the Morningstar Technology and Communications Index. That is not to say big companies are not affected; pandemic-darling Zoom (ZM) is down 64% off the highs notched last February.

Losses have been bubbling beneath the surface for some time. The worst performers in the Morningstar US Technology and Communications Index have been in decline for more than six months in many cases.

Rising bond yields and the prospect of higher rates from the US Federal Reserve are putting pressure on valuations at the smaller and more “extreme” end of the technology market, says Jun Bei Liu, portfolio manager at Tribeca Investment Partners.

“The smaller end, especially unprofitable tech, has been underperforming for the last 6 months, intensifying in the last three months,” says Liu.

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“These are parts of the market where the valuations are most extreme. Large cap tech stocks are not that expensive and make a lot of cashflow. That’s why they’re much more resilient... The smaller end tech companies tend to be like concept stocks and don’t make any money. You require lots of hot money flowing into those companies to keep them afloat.”

Technology mega-caps like Apple, Meta and Alphabet are down this year but proving more resilient to the selling pressure. The FAANGs, an acronym representing five US tech giants are 13% off their highs on average. Meta has fallen 2% year-to-date, with Alphabet and Apple down 4% and 5%, respectively.

Size does matter and larger cap stocks have been more insulated from the selloff. Of the 229 stocks in the Morningstar US Large Cap index, just 4% are more than 50% off their 52-week high. Performance is down this year, but half the decline notched by the broader US technology index: -2.5% versus -5%.

Markets in Australia and Europe, weighted towards the basic materials, financials and automaking sectors, have not been as impacted by the poor performance of US technology. The broad market Morningstar Australia and Europe indexes are down 0.6% and 1.3%, respectively year-to-date. Just 3% of the over 1,500 stocks in the Morningstar Europe index are more than 50% off their 52-week high. Shares are showing similar strength at home.

Australian technology has also dipped in the new year, with the Morningstar AU Technology down 10% year-to-date. Poor performance partly reflects the outsized influence of Afterpay (ASX: APT) on the local index and the share price rout at Block (SQ), its soon-to-be owner. The buy-now-pay-later giant is a third of the Morningstar Australia Technology index and is down 18% this year—the same as Block, whose share price it tracks closely. The US payments giant traded at US272 when the takeover of Afterpay was announced on 2 August. It closed Friday at US$133. Other local technology stocks to struggle include Nuix, Appen and Nextdc, down between 11% and 23% over the last six months.

Expect weakness in the more speculative corners of the technology sector to continue into the new year, says Liu.

“For 2022, it is going to be more or less the same story because those stocks are so expensive. We have a valuation issue. We don’t have a growth issue.”

is a reporter and data journalist with Morningstar. Tweet him @lewjackk or get in touch via email

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