As many investors flee to safety, bracing for higher rates and even stagflation, some tech investors see an opportunity in oversold tech stocks.
The market rout this year has led to widespread pessimism. Bank of America’s latest monthly survey of global fund managers found allocations to equities at the lowest since the global financial crisis. Many mid-year outlook reports are also wary of rising rates and positioning portfolios for stagflation.
Amid the bearish gloom, however, some tech investors see an opportunity. Valuations for once-expensive tech stocks have fallen during this year’s sell-off, they say, and slowing growth could force the U.S. Federal Reserve to pivot early from its rate hike path.
Cathie Wood, CEO and chief investment officer of Florida-based Ark Investment Management LLC, noted the large allocations to cash, consumer staples and commodities in the Bank of America survey, with technology allocations well below the benchmark. That leaves room for products such as her Ark Innovation ETF to outperform, “especially as the cyclicals experience some indigestion,” she said Wednesday at a webinar hosted by Toronto-based Emerge Canada Inc.
The US$7.9-billion Ark Innovation ETF became famous when it caught the early pandemic rebound as interest rates were slashed to zero, posting a 153% annual return in 2020. It has since given up those gains as innovation stocks were battered in a rising interest rate environment. The ETF is down by 49% this year.
However, Wood said the investment environment may once again favour innovation stocks. She said there are deflationary signals in the bond market, with the yield curve inverting and 10-year U.S. Treasuries struggling to stay above 3% even with aggressive rate hikes.
“That’s telling us the bond market is not worried about inflation and the Fed will — we think within the next three to six months — change its tune and may even reverse its position by the end of this year,” she said.
Ryan McCormack, senior equities ETF strategist with Invesco U.S., also said tech stocks could rebound this year. McCormack said valuations for companies in the Nasdaq 100 index have come down to levels “much more in line with history.”
“Unsurprisingly, when you see a market sell-off and negative sentiment, you will see investors move toward your traditionally defensive sectors — like utilities or consumer staples,” he said in an interview. “We’ve seen some of those defensive valuations begin to get bid up and we’ve seen these growth-oriented valuations come down.”
Wellington-Altus chief market strategist James Thorne, who spoke at the Emerge webinar with Wood, said he doesn’t think inflation is an enduring problem. Rather than the “era of secular stagnation” being over, Thorne attributed the surge in inflation to the combination of Covid-related supply problems, monetary stimulus and the inflationary shock from Russia’s invasion of Ukraine.
A slowing economy will force the Fed to change course, he said: “We say they pivot and cut rates in 2023. If that’s the case, you want to buy innovation; you want to buy technology.”
Many economists don’t see the pivot coming that quickly. The Fed’s June dot plot showed the median year-end interest rate projection was 3.4%, rising to 3.8% for the end of 2023.
In its latest fixed-income monitor, National Bank forecast the Fed raising its overnight rate from 1.75% to 3% this quarter, where it will remain until a 25-basis-point cut in the first quarter of 2024. Scotiabank sees the Fed hiking to 3.25% this year and holding through 2023, while RBC forecast the U.S. interest rate rising to the 3.25%–3.5% range this year, with cuts coming in the second half of 2023.
As a result, many investors are happy to stick to defensive sectors and wary of moving back into growth stocks too soon. National Bank’s monthly equities monitor for June had IT underweighted by 5.5%.
But Wood said the case for innovative companies is strong.
“The last two years — Covid, then supply chains and then war — have created so many problems,” she said. “There are so many more problems to solve, and that is when innovation gains traction. The turmoil has increased our confidence that these platforms are going to scale.”
– With files from Daniel Calabretta