US inflation data, labor market data or Powell’s speeches were more relevant than ‘Big Techs’ results to answer this question.
In our work as technology stock analysts, we face numerous questions. Will the bag fall? Do you like Microsoft? Why do you believe that Apple will not be a good investment? What is the effect of restrictions on the sale of GPU chips to China on NVIDIA’s actions? What is the best opportunity to invest in technology in Brazil?
Within this “flood” of questions, one of the most common – whether from individuals or institutional clients – is “is it time to buy tech stocks again?”. The question is so present and the answer so important that we decided to devote the entire report to its research. And based on that, we are writing this article.
Macro is “who’s boss” in today’s market
As much as we can talk about specific aspects of companies – which would lead to conclusions about their performance or trends – “macro” is the dominant theme in explaining stock movements. In this sense, data on US inflation, the labor market or Jerome Powell’s speech are much more relevant than the results of Apple, Amazon or Google. On the technical side, we measure this phenomenon by increasing correlations between stocks of the same type. For example, if we analyze the stock returns of software companies, their dispersion has decreased significantly in recent months.
And then what explains the decline of several papers? The main factor is the increase in interest rates. And the “power” of this variable is easy to visualize in the chart below, which illustrates the interest rate on the 10-year US Treasury bond and the multiple (enterprise value/revenue) of US software companies (which is good assignee for technology companies as a whole).
After a large expansionary movement in this multiple during the pandemic, there has been a huge contraction in it, reaching levels below long-term history. This was accompanied by a strong increase in the quoted rates, to the highest level in a long time. In short, a software company that generated X annual revenue and was worth 10X a year ago is now worth 5X.
US 10-Year Treasury Bond Interest Rate X Technology Company Multiple
So what to do?
If the movements are relevantly explained by the 10-year rate, the most important question becomes: what will happen to it?
We are not macroeconomists, so we listen to them. Initially, the consensus is that there are short-term risks for them. However, if history is anything to go by, it is reasonable to assume that at some point they will adjust and return to lower rates – as in any economic cycle.
With this in mind, we believe that the answer to the question in the title of the article lies in the individual, their goals and risk parameters. For easier understanding, we have divided them into two groups:
Group 1: If you need to make returns in shorter terms or you need liquidity on the invested amount, in such a way that you can be forced to sell at a certain moment (and in the short term), our recommendation is that you have patience and do not enter this market! This is based on two points:
- If the market consensus is correct, 10-year rates should continue to rise, which should lead to an additional “leg” of devaluation in more companies and, consequently, in their values.
- Exchange rate uncertainty is likely to cause market volatility to remain high, increasing the risk of selling on an unfavorable day/week/month.
Group 2: If you are a long-term investor (at least 5 years) then this could be an attractive buying opportunity. This for several reasons:
- It is impossible to “hit the bullet”. Even us professional investors can’t quite figure out the perfect day to buy stocks that we’ll carry for years to come.
- It is reasonable to assume that in the very long run there is some convergence of the historical average rate and, consequently, of multiple firms. This average (of 10, 12 years) is higher than the multiple trading today.
- The “burden”, that is, the average performance of technology companies is superior to that of the rest of the economy, at least from a growth standpoint. As Satya Nadella (CEO of Microsoft) says, the technology sector will only gain a share of GDP. Digital transformation, cyber security, e-commerce are some secular topics that support the continuity of this thesis. Therefore, a stock’s valuation – measured simply by revenue growth or results – should be higher than the economy’s average (which could be represented by a stock index like the Ibovespa or the S&P500, for example).
So here’s a tip: get organized and think about your financial goals! This step is necessary to make money in the stock market, especially in a sector as interesting and inspiring as technology.
This article had valuable input from Thiago Kapulskis, IT sector analyst at Itaú BBA.