Lessons Learned From This Year’s Tech Stock Bust

Lessons Learned From This Year’s Tech Stock Bust

Tech stocks are bearing the brunt of the blame for the stock market’s recent dip into bear territory; so far this year, as of the date of publication of this article, the Morningstar U.S. Technology Sector Index was down 27%, reports an article in Morningstar. The index is being dragged down by Microsoft (down 22%), Apple (down 17%), Nvidia (down 44%) and Salesforce.com (down 37%). The communications sector isn’t faring much better: Meta is down 44%, Alphabet is down 22%, and Netflix has plummeted a shocking 73%, leading to the Morningstar Communications Services Index dropping 29% so far this year.

But there may be good reasons behind the tech stock losses, the article contends, and investors need to be taking the long view of the market this year. With tech stocks the cheapest they’ve been since March 2009, investors can also use the downturn as an opportunity to boost their financial goals. And there are lessons to be learned from the tech stock sell-off, says Morningstar head of research for the Americas, Tyler Dann. Perhaps the biggest lesson is that herd mentality can often fuel the popularity of a stock, “creating a disconnect between the price people pay…and what it’s worth.” Those who stampeded into Nvidia, for example, in late 2021 suffered great losses. But those who were ahead of the curve and bought it back in 2019 have almost quadrupled their money. Looking at the last 3 years, the tech stock index is still up 72%, the communications sector is up 21%, and the overall market is still up 40%.

Many strategists believe that the current tech stock decline is a correction to the excessive gains from the last few years. At the start of the pandemic, investors were seeking companies that would endure through the turmoil, and those companies became crowded investments. That crowd pushed those stocks to record highs and lofty valuations. Tech stocks were overvalued for most of last year, according to Morningstar’s price/fair value estimates. Then, as the world reopened, investors shifted into disruptive companies. Dann points to Carvana as an example: the stock skyrocketed from $22 in 2020 to $360 in August 2021…and is now trading below $40, the article details.

But persistent inflation and the Fed’s hawkish policies provided a catalyst for the market’s downturn. Tech stocks and growth companies are generally viewed as particularly vulnerable to rising interest rates, because stock valuations are calculated by assessing the current value of future earnings. Higher rates now mean lower value in the future. And fast-growing companies that base their value on earnings far in the future—years or even decades—have gotten hammered even more as the discount rate goes up.

But Dann also revealed that Morningstar Investment Management believes that many big-name, high-quality tech companies such as Meta and Google “have experienced improved valuation of late.” That provides an opportunity for investors to build their portfolio with strong companies that have solid long-term prospects; as the bad companies get weeded out, the strong companies whose valuations are coming back down to where they should be will still remain.