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The 2022 Tech. Sector Collapse

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Rising interest rates and inflation have been huge drivers of the sector rotation to Value-based shares, away from Growth (i.e. Tech. and Innovation) shares, which has seen Tech. shares down more than 30% from their highs in November 2021.

In our January 2022 Market Outlook, we wrote: “We believe there is a sense of caution going into 2022, given relatively high valuations and rising interest rates. Sector selection is key favouring more defensive and Value-based equities as opposed to expensive Growth (FAANG) sectors that are highly vulnerable to interest rate increases.” Please click here to view our 2022 market outlook .

Year to date, Value has outperformed Growth in the US and globally (MSCI) in both the large, medium, and small-cap equity sectors.

 

What’s happened to Growth and Tech. shares?

The FAANG shares comprise Facebook (Meta), Apple, Amazon, Netflix, and Google (Alphabet). In 2022, Facebook is down -48%, Apple -24%, Amazon -36%, Netflix -69% and Google -23%. Other Innovation shares like Tesla and Zoom are down -42% and -41% respectively.

FANGM performance relative to S&P 500

The FAANG shares (including Microsoft) made up as much as 23% of the S&P 500 index in 2020, and this percentage has fallen to ±19% of the index. This high percentage represents a large concentration risk to investors, particularly for Growth and Innovation focused funds and ETFs.

FAANGMs Market Cap Share of S&P500

A lesson from the last year is that the fear of missing out and herd mentality have caused a disconnect between the price one pays for a share and its real value, with many investors getting caught up in the story of Growth businesses rather than looking at valuations.

From a valuation perspective, the Morningstar Tech. Stock Index had a price to earnings ratio of 29 at the end of 2021, compared to its 10-year average of 20, which presented warning signs that the Tech. sector was overvalued.

We also warned investors to proceed with caution in our newsletter in March 2021 given the high valuation of Growth shares.

Those who only bought into the 2021 Tech. and Growth stock mania have unfortunately suffered large losses. The graph below indicates some of the most popular Tech. shares and their declines from their peak.

Tech shares and their declines from their peak

Source: Datastream; data to 06.05.22 in US$

What is the difference between Growth and Value investing?

Simplistically, Value companies are seen as traditional and boring as opposed to Growth companies whose characteristics often include being innovative and exciting. Over time, Value investing has outperformed Growth investing. But there have been long cycles where one style has outperformed the other.

Below, we outline the distinctions between Growth and Value shares and how they perform over time through different market cycles.

Value vs Growth

Value vs Growth: Long-term performance (in USD)

Over the long-term, Value has outperformed Growth, but the road is seldom smooth. For much of the past decade, during which developed world interest rates were close to zero, Value investing has been out of favour. This means that the market gap in fundamental valuations between the most highly favoured shares and least favoured shares was at extreme levels. In recent years we have seen increasing evidence of the type of erratic behaviour that we typically see close to the top of Growth investment cycles.

Value vs Outperformance

Value vs Growth: Performance comparison per decade (in USD):

Value vs Growth: Performance comparison per decade (in USD)

Growth has outperformed Value over the past decade largely due to a long period of low-interest rates and inflation. With interest rates and inflation on the rise, this will diminish Growth valuations and the Value sector should start a new cycle of outperformance. The graph below shows the numerous valuation metrics that either benefit or disadvantage Growth and Value sectors.

What is driving value stocks

What to do in volatile market conditions?

  • With a high concentration of Growth and quality stocks in most Unit Trust and ETF funds’ equity allocation, it’s an important time to consider Value companies as a key position in an investment portfolio.
  • Ensure your portfolio is well-diversified and not concentrated in a single sector or asset class.
  • Make sure your financial plan is up to date. It’s also critical to ensure that the risk you take on in your investment portfolio matches your financial plan, especially when nearing or during retirement.

Speak to one of our Client Portfolio Managers if you require a review or analysis of your investment portfolio or click here to start your financial plan.

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