The S&P 500 Technology sector was bombarded by bad news from all directions over the past week: Facebook’s lack of control over its customers’ data created a firestorm, the government’s prohibition of Broadcom’s bid for Qualcomm disappointed investors, and the future of autonomous cars was thrown into doubt after one of Uber’s cars hit and killed a pedestrian. It’s hard to sugarcoat that trifecta of headlines.
Up until last week, the Tech sector had been a workhorse, leading the stock market higher. The Tech sector is up 7.8% ytd through Tuesday’s close, outperforming all other S&P 500 sectors as well as the S&P 500 itself, which is up 1.6% over the same period (Fig. 1). Tech is also the leading sector y/y, up 31.8%, compared to the S&P 500’s 14.5% appreciation.
Since the Tech sector peaked on March 12, the picture is bleaker. Here’s the performance derby for the S&P 500’s sectors from the tech peak through Tuesday’s close: Utilities (0.9%), Real Estate (-0.2), Industrials (-1.3), Energy (-1.6), Consumer Discretionary (-1.7), Health Care (-2.1), S&P 500 (-2.4), Financials (-2.7), Telecom Services (-2.8), Consumer Staples (-3.2), Tech (-3.3), and Materials (-4.5). One of the worst-performing industries over that period, among those we track, is Internet Software & Services, home to Facebook and others, which is down 6.8%.
That said, the declines over roughly the past week are a drop in the bucket compared to the gains over the past year. For example, Internet Software and Services rose 25.0% y/y. Our hunch is that while Facebook may need to spend more on lobbying and complying with regulations, consumers won’t drop their Facebook habit in the wake of this week’s revelations because no one assumes that their Facebook postings are private.
Likewise, investors have a short memory, and the failed Broadcom/Qualcomm deal was quickly overshadowed by Salesforce.com’s deal on Tuesday to buy MuleSoft for $6.5 billion. And while the march toward autonomous vehicles may be temporarily stalled, it’s highly likely development and testing ultimately will continue.
Let’s take a look at where some of the S&P 500 and Tech sector’s data stands after this rough week:
(1) Earnings holding steady. It’s early days, but so far earnings estimates for the Tech sector and the S&P 500 have held up after accelerating early this year, thanks to the boost from the lower tax rate companies are enjoying (Fig. 2 and Fig. 3). The Tech sector had among the fastest earnings growth of all the sectors in 2017, and its expected earnings growth in 2018 and 2019 places the sector in the middle of the pack compared to other S&P 500 sectors.
Here are analysts’ estimates for the S&P 500 sectors’ 2018 earnings growth: Energy (69.9%), Financials (29.3), Materials (23.3), S&P 500 (19.5), Tech (19.1), Industrials (18.8), Consumer Discretionary (16.8), Telecom Services (15.0), Consumer Staples (11.7), Health Care (11.5), Utilities (4.8), and Real Estate (-16.1).
S&P 500 net forward earnings revisions, which were in positive territory for most of 2017, grew even more positive over the past three months for both the S&P 500 broadly and its Tech sector (Fig. 4 and Fig. 5).
(2) Earnings support P/Es. Despite last year’s 19.4% increase in the S&P 500 price index, valuations for most sectors and for the broader market still look reasonable assuming the forecasted earnings growth materializes. The S&P 500’s forward P/E was 17.2 as of March 15, down slightly from 17.9 a year ago. That’s only slightly higher than the 16.2% forward earnings growth analysts are forecasting for the S&P 500.
The Tech sector’s forward P/E has risen slightly over the past year, to 19.1 from 18.0 (Fig. 6). That doesn’t seem horribly high relative to the 14.4% forward earnings growth forecasted.
Investors shouldn’t count on much more multiple expansion because next year, earnings should grow at slower, more typical rates as the tax cuts are anniversaried. Here are the 2019 earnings growth rates by sector that analysts currently project: Industrials (12.5%), Consumer Discretionary (12.4), Energy (11.3), Tech (10.9), Financials (10.6), S&P 500 (10.3), Health Care (9.7), Materials (9.7), Real Estate (9.6), Consumer Staples (8.5), Utilities (5.4), and Telecom Service (1.2).
(3) IPO resurgence. The current bumpiness in the market comes as the IPO market was just getting warmed up, especially for some of the unicorns in the Tech sector. There have been 34 IPOs priced so far this year through Monday, which is up 47.8% from the same period last year, according to Renaissance Capital. And ytd through Tuesday’s close, Renaissance’s IPO index remains in positive territory, up 3.8% compared to the 1.9% gain in the S&P 500.
There are some very large IPOs waiting to be priced in upcoming days. Most notably, Dropbox, a cloud storage company, is slated to raise more than $600 million in an IPO scheduled to price tonight and trade Friday. Despite the market turmoil, the company raised the range within which it hopes to price its shares to $18-$20 from $16-$18. That IPO follows last week’s $192 million offering from Zscaler, a cybersecurity company, which has rallied by 102.8%. And music-streaming company Spotify is planning to do a “direct listing” of its stock on April 3, eschewing the traditional IPO process. Shares will be sold directly to retail investors.
All three companies are in the red. Spotify lost €1.24 billion last year, while Zscaler lost $35 million in the fiscal year ending July 31 and Dropbox’s bottom line was negative by $112 million in 2017. Many a banker must be crossing fingers that the market’s volatility calms down so that the window for IPOs doesn’t slam shut.
Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.
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