The Nasdaq’s performance now encompasses a higher degree of volatility, as evidenced by the 5.5-9% corrections in the Invesco QQQ Trust (QQQ), which has now become the new normal in a macro environment where the hawkish rise Fed interest rate policy is seen as unfavorable to high-value, unprofitable technology stocks.
Source: Initial chart from Trading View
For investors, QQQ tracks the Nasdaq-100 index which includes Apple (APPL), Alphabet A (GOOGL), Alphabet C (GOOG), Microsoft (MSFT), NVIDIA (NVDA), Meta labs (FB), Amazon (AMZN ), Tesla (TSLA), Adobe (ADBE), and PayPal (PYPL). These are the top holdings out of a total of 102.
Assess the risks
There are certainly risks in 2022 in the context of being invested in tech stocks, but I would like to draw investors’ attention to the fact that despite all the volatility, QQQ gained 6%, and that shows that repositioning of the market (in the midst of the rotation from growth stocks to value stocks) does not seem commensurate with the coming pace at which interest rates will rise.
Exploring further, trades are no longer crowded like in 2021 as people seek income or other asset classes to diversify. However, this diversification away from technology does not appear to have affected QQQ’s core holdings which constitute 52.73% of the portfolio. In my observation, this was the case from April to December of this year, when most market gains came solely from AAPL, MSFT, NVDA, TSLA and GOOGL.
Given that the rotation has lacked momentum, I view the tech corrections as a rather subdued market reaction, which also prompts me to dismiss concerns that tech stocks will suffer in the same way they did during the downturn. Internet bubble burst. in 1999-2000. At that time, in the first phase of the bear market, large-cap stocks were doing well, but a large percentage of the other components of the Nasdaq crashed more than 50%. In the end, all components crashed.
However, it was a completely different Nasdaq, with the top stocks at the time being Cisco (CSCO) followed by Microsoft and then Intel (INTC), or the networking, software and semiconductor sectors respectively. . Today it’s more about social media, online advertising, internet marketplaces, electric cars, cloud, smartphones and virtual reality. In short, tech is now fully integrated into all spheres of economic and social life compared to twenty-two years ago.
Considering the inflation factor
In slight moderation, QQQ’s other holdings appear to be impacted as investors become more selective, placing more emphasis on quality (free cash flow, balance sheet, moat, etc.) and valuations. However, here too, the rise in inflation, currently above 7% against 3.75% in 1999-2000, could prove more difficult for value stocks such as banks, because their customers are suffering from the rise in prices and are faced with the rising cost of doing business. Indeed, as the chart below shows, Bank of America (BAC) and Berkshire (BRK.B) saw a steeper drop in their total return level in August 2008 than Apple or Microsoft when inflation was greater than 5%.
Manufacturers are also expected to suffer from soaring raw material and labor costs. As for technology, it should better withstand high inflation thanks to its ability to use software, AI and automation tools faster than companies in other sectors of the economy. These tools allow them to reduce operating costs and better circumvent wage inflation. Examples are the ability of FinTechs like PayPal (one of QQQ’s current underperformers) to lower money transfer fees for customers compared to traditional banks and businesses using cloud-based collaboration instead. having to invest in expensive infrastructure.
Technology should continue to outperform as enablers of digital transformation
Additionally, being relatively less dependent on physical interactions caused by variant uncertainty, technology stocks are less likely to see a reduction in their profitability. Here, some will note that Apple’s share of revenue from its App Store ecosystem is growing faster than for devices, and that Tesla is considered a car internet company.
Historically, as the chart below shows, big tech gross profit margins have increased or remained constant for the past five years, including 2021, a year characterized by rapidly rising inflation.
Thus, inflationary pressures on the economy from 2022 onwards are likely to put valuations behind the scenes, with technology, especially the most profitable ones, likely to continue to post positive returns. That said, the technology remains heavily reliant on semiconductors, a sector that needs to be watched closely for some short-term pain when some of the big names report earnings in the last week of January. Finally, looking at the performance of the Nasdaq in 2020 and 2021 when it gained 43.64% and 21.39% respectively, even a 10-12% gain in 2022 would put it in positive territory.
Disclosure: I’m a long-time Apple follower. This is an investment thesis and is intended for informational purposes. Investors are urged to do further research before investing.