Technology stocks and related exchange traded funds have led the rally off the March lows, but some argued that valuations may “have it a wall,” warning that investors shouldn’t anticipate this segment to maintain its lead.
Over the past month, the technology heavy Invesco QQQ Trust (NASDAQ: QQQ) rose 4.9% and the Technology Select Sector SPDR ETF (NYSEArca: XLK) gained 2.9% while the S&P 500 increased 5.5%.
Jefferies analysts contend that there may be limited additional upside over the near term due to the elevated valuations in the high growth tech segment. To put this in perspective, QQQ shows a 31.5 price-to-earnings and a 6.4 price-to-book, and XLK trades at a 27.1 P/e and 6.8 P/B, compared to the S&P 500’s 23.5 P/E and 2.9 P/B.
“At some point multiple expansion will run out, and that the next leg of growth has to come from fundamentals,” Jefferies analyst Brent Thill said in a note, according to Bloomberg. While the backdrop for fundamentals “remains strong,” he added, expectations are elevated and “investors will need to be patient in the [near term]before the ride commences again.”
For example, earnings results from Microsoft Corp., International Business Machines Corp., Texas Instruments Inc., Intel Corp., and Snap Inc., all pulled back after their quarterly earnings reports.
Jefferies highlighted “the negative reaction to last week’s earnings” as evidence for valuations having limited additional upside.
The S&P 500 information technology index increased 16% so far this year, and it is now the top percentage gainer among industry groups. The segment enjoyed a 30% surge over the second quarter, its biggest quarterly gain since 2001. Meanwhile, the broader S&P 500 is more or less flat for the year.
“Pockets of extremes may be developing in tech valuations,” Bloomberg Intelligence analyst Gina Martin Adams said, adding that “relative valuations for S&P 500 technology companies are back near the cycle peak,” although they “still pale in comparison with the late 1990s.”
Investors will be focusing on the tech segment again this week as major technology names report quarterly earnings, including Apple (NasdaqGS: AAPL), Amazon.com (NasdaqGS: AMZN), Facebook (NasdaqGS: FB) and Alphabet Inc. (NasdaqGS: GOOGL).
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