Investors are grappling with how to play heavyweight U.S. technology shares, which are trading well above long-term valuations despite a sell-off last month that took some air out of the stocks.
After leading the rally back from the market’s March lows, the S&P 500 information technology sector (.GSPT) has underperformed recently and was among the weakest within the S&P 500 (.SPX) in September.
The tech sector remains down about 8% since peaking on Sept. 2, compared with about a 5% decline in the S&P 500.
Even with the sell-off, the S&P 500 technology sector is trading at about 25 times forward earnings and at a nearly 55% premium to its 10-year average, IBES data shows, according to Refinitiv analysts. The sector’s P/E hit 28.4 on Sept. 3, its highest since 2004.
The S&P 500’s forward price-to-earnings ratio is now at 21.8.
While tech valuations remain high, investors still see it as the place to be if coronavirus cases continue to grow and the economy falters further.
“The technology sector has its own issues, which is whether or not it’s gone too far, too fast,” said Rick Meckler, partner at Cherry Lane Investments, a family investment office in New Vernon, New Jersey.
“But if the virus is going to be a continued weight on the fabric of the country for the rest of the year and into next year, technology still seems to be the best place in terms of protecting your money.”
Lori Calvasina, head of U.S. equity strategy at RBC Capital Markets in New York, said in recent commentary that its September U.S. equity investor survey suggested there was no clear consensus on what to do with big-cap tech and internet names.
“While 38% believe investors should be buying these names on weakness (the most popular choice), another 36% believe that investors should be taking profits,” she wrote.
Tech has by far the biggest influence on the S&P 500, with a weighting of 28%, based on S&P Dow Jones Indices data. The next-biggest sector is health care, with a weighting of 14%.
The two biggest companies by market capitalization in the tech sector - Apple (AAPL) and Microsoft (MSFT) - also have valuations well above their long-term averages.
Apple is trading at 30.1 times forward earnings, or a 116% premium versus its 10-year average, while Microsoft is trading at 31.4 times, or a 79% premium, according to Refinitiv’s data.
Still, the sector may not be as overvalued as it was in 2000, during the dot-com bubble.
“Our current valuation composite is 60% below that of the dotcom era; and overall profitability, dividends, and balance sheet strength are simply in a much stronger position now versus 20 years ago,” Brian Belski, chief investment strategist at BMO Capital Markets, wrote in a note Tuesday. He thinks investors should view weakness in the sector as a buying opportunity.
In 2000, the tech sector’s weighting in the S&P 500 was 21%, S&P-Dow Jones data shows.
The next test for the tech group may be the upcoming earnings season.
Many technology companies have benefitted from the quick shift to working from home because of the pandemic, and strategists say that trend is likely to continue.
Analysts expect earnings from S&P 500 technology companies to decline just 0.6% from year ago in the third quarter, the smallest decline among all sectors. They expect earnings for the entire S&P 500 to fall 21.3%, IBES data from Refinitiv shows.
Tech will likely continue to be the dominant player in the market, said Quincy Krosby, chief market strategist at Prudential Financial in Newark, New Jersey.
“It will always be,” she said.
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