Tech’s shaky start to the year doesn’t necessarily mean deeper problems

It may only be two weeks into the new year, but Wall Street’s decision to throw the tires on the long tech rally has set a new tone.

After a surge supercharged by a pandemic-induced surge in digital spending, a correction like this seemed overdue. This one dealt a severe blow to some of the most overheated corners of the tech markets. Some of the emerging tech giants of recent years, such as Nvidia and Salesforce, have lost more than 20%. But the impact has been far from uniform, and it’s too early to tell if this is anything more than a short-term adjustment that sets a floor for another rebound.

Big Tech’s defensive qualities once again stood out. Whether it’s good or bad economic times, Wall Street has decided that backing this handful of companies is like putting money in the bank. Thanks to Apple’s year-end rally, the overall value of the five (which includes Microsoft, Alphabet, Amazon and Meta) has retreated only slightly since early November, when the tremors first swept through other parts. of the market.

At least that remains true on the long tech rally: the concentration of market leadership among a handful of stocks is only getting stronger. Whatever lawmakers and regulators may dream of doing to reduce their power, investors have decided that Big Tech’s share of industry profits will only increase.

The story is very different elsewhere. The Nasdaq fell 10% from its all-time high in early November, and high-growth stocks fared much worse. The Bessemer Emerging Cloud Index — a collection of 58 fast-growing software companies that have been among the most popular in the tech boom — has fallen 27% in the past two months.

At the same time, what passes for value in the tech world is largely unscathed. Intel and IBM may face serious challenges, but shares in both have been rising since November.

The main questions now are: how far should this adjustment go? And has something fundamental changed in the attitude of the stock market towards technology that will result in profound change, curbing the inflow of capital into the sector and forcing a rethink of investment plans? more expansive business?

The prospect of higher interest rates was the immediate cause of the decline. The knee-jerk reaction of the stock market is always to write down high-growth companies with more advanced earnings. But it’s unclear if anything is materially different about the trade outlook for them – particularly if the rate outlook itself reflects a belief in stronger economic growth to come.

That said, there is definitely room for more air to escape from the market. Even after the recent reset, the Emerging Clouds Index is up 934% since its launch in 2013, compared to a 185.4% rise in the S&P 500 over that time. The 58 software companies now have a combined value of $1.9 billion – and that doesn’t include Microsoft, which alone is worth $2.35 billion.

The average software stock is trading at about 12 times sales, a 50% premium to the average multiple over the past six years, according to Jefferies’ analysis.

Many of these companies are expected to experience declining growth rates this year, further testing the market’s resolve. After a surge in demand during the pandemic, when customers purchased software to continue operating remotely, there are valid questions about how much spending will be carried over from future years and to what extent companies will suspend their digital reviews to work. on the changes already defined. moving.

Comparisons with the strong start reported by many technology companies at the start of 2021 will also lead to lower year-over-year growth rates.

This sets up a more cautious period ahead in public markets. However, that does little to shake the strong age-old forces that have underpinned the rise of the industry, from the shift to the cloud to the rise of online shopping, working and entertainment. And private market investors, who have come to play a much larger role in fueling the latest generation of new growth companies, generally react more slowly to changing stock prices. According to CB Insights, global venture capital investments doubled last year from what was already an all-time high, representing a wall of money that continues to drive up valuations.

The year has started precariously and the market has plenty of room to take a bigger slice of the more inflated valuations. But it’s far too early to say that January’s adjustment represents a deeper change in the fortunes of the tech industry.

richard.waters@ft.com

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