Will this year mark a tipping point for Big Tech? Following a sudden and hawkish pivot by the Federal Reserve, the world’s largest technology companies have suffered a pummeling in the opening weeks of 2022. 

This is new and unfamiliar terrain. Looking back, outperformance for the Nasdaq — along with the wider US growth stock complex — has been unparalleled. The numbers don’t speak for themselves so much as they scream. The Nasdaq swaggered through the 2010s, leading all major stock indices. It soared by more than 5 times during the decade. Then, in 2021 alone, Apple, Microsoft, Amazon, Alphabet and Meta Platforms tacked on a cool $2.5 trillion in market capitalization. Share prices were bolstered by the pandemic, which aided all things digital and proved immune to everything from lockdowns to legislation aimed at regulating their business models. An aura of invincibility took hold in tech.

But all that is history. Looking ahead, we serve up a bold forecast for our readers: the period of outperformance for technology stocks is over … in other words, the most enduring trend of the last decade has sputtered to its endpoint. Of course, a few weeks may be too short to declare a durable trend change. We must tread carefully here with a heightened awareness that big turns in financial markets are rare events. In fact, an occupational hazard for investment professionals is overreacting to the smaller turns, mistaking a technical adjustment for the secular, career-enhancing kind. Still, before spitting out the thesis, let’s take a discerning swill.

Speculative Fever Evident

First, consider the backdrop to the technology sector and, at the risk of succumbing to Silicon Valley’s jargon, “disruptive” growth stocks. While other asset classes have been on life support for years (look no further than value-oriented, international stocks), the technology sector has been busy sucking up all the oxygen in the room. And perhaps for good reason. The stories have been captivating, ranging from the power of monopoly pricing (hard to dispute) to the multi-billion dollar potential of an iPad strapped to a stationary exercise bike (ok, we never got that one).  

Now, to be fair, the Nasdaq hosts a variety of growth stock types. Big Tech, with enormous earnings, is different than the unprofitable, tag-a-long companies that try to get in on the action. But they all share similar properties: lofty valuations and sky-high expectations for future returns. These are not good starting conditions for continued outperformance.

The issue for investors, then, is how late in the game are we? Here, we have several signals. One is particularly conspicuous: the rise of cryptocurrencies, a freakish offshoot of the Nasdaq’s outperformance. In fact, Bitcoin, which is increasingly tracking swings in the Nasdaq, is now providing important signals of the level of speculation built into digitization and technology as an overall investment theme. As investment cycles mature, investors become more willing to take on more risk (if this does not seem intuitive, see me after class).

Just how hyped is crypto? Put plainly, crypto has become a hotbed of speculation. If you doubt that, then note the promoters now flogging it to the public: Kim Kardashian, Snoop Dogg and Steven Seagal all have crypto partnerships (and, not to be unseen, Matt Damon’s “fortune favors the brave” commercial). Celebrity endorsements appear at the end of trends, not the beginning. 

To be sure, speculative trends often stay in place longer than most think. The circus remains open and people eagerly pay the entrance fee. Yet there is also the flip side: once a speculative fever breaks it tends to last a long time. This is deeply rooted in human behavior. Momentum stalls and the fun tops out. Everyone scrambles to leave. Exits get crowded. 

On the Nasdaq exchange, more than 50% of stocks have been cut in half from their 52-week highs. Even Big Tech has lost its footing. Suddenly, paying up for story stocks seems imprudent. Suddenly, antitrust risks seem too much (the one area with bipartisan support in the US). Suddenly, markets stop believing Big Tech is the best place to be in a rising rate environment. And so, the tents are packed up and people move onto another asset class. This is now happening in real time.

Macro Conditions Not Supportive Of Future Outperformance

Looking out longer-term, chronic macro headwinds will constrain the tech sector. Consider the specific topology of the 2010s: low growth and low inflation with a persistently strong US dollar and falling bond yields. US growth stock dominance was so potent precisely because, tech provided a rare shot in the arm — an inoculation against a growth-deficient world. 

Yet trends that dominated the 2010s are now disintegrating. The 2008 financial crisis did not inaugurate higher macroeconomic growth. Covid did and will. Today, the path ahead is becoming more visible, with little dots of guiding lights rapidly appearing. Households in the major economies have deleveraged and are borrowing again. A capital spending cycle has finally begun. And, a structurally looser fiscal stance can be seen across most major economies. This is completely new territory, shaped by stronger global growth, higher energy prices, higher inflation, tighter monetary policies, a weaker US dollar and an abating pandemic. These are now a structural part of the unfolding macroeconomic landscape. 

Investment Implications

The last few weeks have witnessed a violent rotation into the less glamorous, out-of-favour value stocks at the expense of growth stocks. Some 90% of foreign indices have also outperformed the US stock market. The big question from here is twofold. First, can these rotational trends continue? And secondly, can other parts of the market deliver positive returns, even while the previous winners decline in value? After all, technology (now accounting for 24% of the S&P 500) has been a big driver of investor appetite and US stocks are often seen as bellwethers of the global economy. Contagion could — and historically has — dragged down all sectors.

From a valuation perspective, there is certainly scope for a multi-year rotation. The ratio between value and growth hit a 20-year low late last year. MSCI US Growth now trades on 35.2 forward earnings, while MSCI AC World ex-US Value trades on just 10.2 forward earnings. Many stock market indices outside of North America are lower today than they were prior to 2008 crisis. 

But valuations do not drive markets in the short-term. Rather, the period ahead will be heavily impacted by macro developments between the US and the rest of the world. Consider that America is now entering a rate hiking cycle. Washington, now home to a certain political froideur (where a defrosting is unlikely anytime soon given deep divisions), will pass a much more watered-down version of the previously planned $4.5 trillion of stimulus. Both monetary and fiscal stimulus have suddenly turned restrictive.

Macro conditions in much of the rest of the world are far different. Most emerging market countries have faced weakening growth, rising inflation and aggressive policy tightening over the last year. These trends are beginning to reverse. This will allow these nations to pause or even reverse monetary tightening. In China, a policy reflation is gaining momentum. High-frequency data shows steady growth stabilization. 

All of this means that the global economy is not heading for recession. And, it is the primary difference between the early 2000s (where a bear market in the Nasdaq pulled down all risky assets) and today. Market corrections without accompanying recessions tend to be shallower and shorter affairs. Investors should prepare for this scenario, limiting exposure to US growth and raising weightings in more value-oriented, international equities. This is only the beginning of a multi-year trend change.