The correction in tech stocks could have further to run – and people still don’t understand the main cause of the sell-off, Deutsche Bank says

A trader works on the floor at the New York Stock Exchange (NYSE) in New York, U.S., March 4, 2020. REUTERS/Brendan McDermid
A trader works on the floor at the NYSE in New York

  • The sell-off in tech stocks over the past few months could have further room to go, Deutsche Bank said in a note last week.
  • The bank argued that the sell-off in tech stocks is not about rising interest rates, but instead about relative earnings growth.
  • Tech stocks likely have more room to consolidate and could even trade sideways until earnings growth catches up with valuations, according to the note.
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The sell-off in technology stocks over the past few months could have more room to go as earnings growth catches up with valuations, Deutsche Bank said in a Wednesday note.

While rising interest rates have largely been blamed for the underperformance of tech stocks relative to cyclicals and the broader market, empirical evidence and fundamental considerations “strongly suggests that rates have had little if any role to play and the relationship might run in the opposite direction,” the note said.

That means going forward, tech stocks can decline along with interest rates, or rise with interest rates, both of which has happened in the past, like in 2013 and throughout 2017 and 2018, when the Fed was raising rates.

“Pre-pandemic relative performance [in tech stocks] was positively correlated with [rising] interest rates,” Deutsche Bank explained.

Instead of rising interest rates, the ongoing weakness in tech stocks has been driven by relative growth in earnings and extended valuations. While the pandemic benefitted relative earnings prospects for growth stocks, the ongoing post-pandemic cyclical recovery is now benefitting relative earnings for the rest of the S&P 500, according to the note.

“Equity valuations depend critically on long-run earnings growth expectations. This is even more so for growth stocks which typically grow earnings around 6.6pp faster than the rest of the S&P 500 annually. Changes in their expected earnings growth therefore far outweigh movements in rates,” the bank argued.

That means the correction in tech stocks could run further as the economic reopening accelerates and companies tied to physical activities like restaurants and casinos continue to see strong underlying trends for their business.

And while the sell-off in tech continues, the sector could instead consolidate sideways for some time until the relative earnings growth is in the sector’s favor, according to the note.

“The strong underlying uptrend in growth stocks means that relative performance could re-align with relative earnings even with a sideways or slightly down relative price movement, and do not necessarily require a selloff,” Deutsche Bank concluded.

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Goldman Sachs outlines the 3 biggest risks facing mega-cap tech juggernauts right now – and explains why regulation is the scariest prospect of all

Trader NYSE
A trader works on the floor at the New York Stock Exchange (NYSE) in New York City, U.S., March 5, 2020.

  • Potential policies from President Biden’s administration represent big risks for mega-cap tech stocks, according to a note from Goldman Sachs.
  • Higher corporate and capital gains tax rates could reduce profits and spur a sell-off by investors who are sitting on big gains, the note said.
  • “The greatest fundamental risk to the continued market leadership of the five largest companies appears to be the potential intervention of regulators,” Goldman said.
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Mega-cap tech stocks like Facebook, Apple, Amazon, Microsoft and Alphabet face growing risks as President Joe Biden moves forward with his agenda, according to a Friday note from Goldman Sachs’ David Kostin.

Those five stocks represent more than a fifth of the S&P 500 as measured by market value, and for good reason, according to Kostin. The tech giants posted strong growth amid a global pandemic and their underlying revenue streams remained durable as other businesses struggled.

And while valuations appear stretched for the mega-cap tech stocks, fast growth and low interest rates justify them, according to Kostin.

But there are three big risks that these tech stocks are facing over the next year, which could lead to limited upside ahead from current levels, Kostin said.

1. Higher Taxes

Tax reform plans from the Biden administration could dent profits and spur selling by investors, according to Kostin.

Biden has proposed raising to corporate tax rate to 28%, though has signaled that a compromise around the 25% level is possible. That tax hike could decrease 2022 earnings for the mega-cap tech group by 9% relative to analyst estimates, according to the note.

A higher capital gains tax rate in 2022 could also lead to weakness in the tech stocks, as some investors who are sitting on big gains might sell in 2021 to lock in the lower current tax rate.

“The FAAMG stocks have appreciated by $5 trillion during the last 5 years, accounting for 29% of the S&P 500 market cap increase during that time,” Kostin explained.

2. Higher Interest Rates

Low interest rates have supported the valuation of high growth, long duration stocks for more than a decade as investors have learned to cope with near-zero interest rates.

But the trend of near-zero interest rates could be nearing its end, based on expectations from strategists at Goldman Sachs. The bank expects the yield of the 10-year US Treasury will rise to 1.90% by the end of 2021, representing a cycle-high since the pandemic began.

“All five FAAMG stocks have above-average duration compared with the Russell 1000, meaning they are especially sensitive to moves in long-term interest rates,” Kostin explained.

This dynamic was on full display in late 2020 and earlier this year. When interest rates rose sharply from November through March, FAAMG stocks underperformed the S&P 500 by seven percentage points.

“A similar period of rising rates in 2H 2021 would likely hamper FAAMG returns,” Goldman said.

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3. Anti-trust Regulation

“Looking forward, the greatest fundamental risk to the continued market leadership of the five largest companies appears to be the potential intervention of regulators,” Kostin said.

Recent appointments made by the Biden administration suggest there is increased risk of a stricter regulatory regime for the FAAMG stocks, as they “face a laundry list of legal battles and investigations over their market power and competitive practices ranging from commercial litigation to DoJ and FTC antitrust lawsuits to Congressional probes,” the note said.

But investors don’t seem to be worried, as shares of Alphabet and Facebook are both higher since the announcement of higher scrutiny of their business practices.

Goldman said investors could be right, and that any antitrust actions have little to no major impact on the companies, but for now the uncertainty remains a big risk for the companies.

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3 reasons to be bearish on Intel despite a new CEO and a $20 billion semiconductor production plan, according to Bank of America

Intel employees
Intel employees.

  • BofA analysts reiterated their “underperform” rating and $62 price target for Intel on Friday.
  • Intel turned in earnings results on Thursday and BofA analysts weren’t impressed by the lack of sales growth and falling margins.
  • BofA says investors would be better off buying shares of Intel rival Advanced Micro Devices.
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Bank of America gave three reasons for investors to be bearish about Intel despite the addition of Pat Gelsinger as CEO and a $20 billion move into the semiconductor production business on Friday.

In a note to clients, analysts led by Vivek Arya reiterated their “underperform” rating and $62 price target on shares of Intel.

The analysts said that the Santa Clara, California-based company has been hurt by rising competition from Advanced Micro Devices (AMD) and others. The team expects “muted” earnings growth over the next three years.

Arya and his team highlighted three specific reasons investors might want to consider alternatives to Intel shares moving forward.

Lack of sales growth

The first reason BofA believes Intel could struggle moving forward is that the firm was unable to grow sales in “a year when PC units and cloud Capex are growing 14-15%.”

Intel reported revenues of $19.7 billion for the first quarter of 2021, a 0.7% drop year-over-year, in Pat Gelsinger’s first earnings report as CEO on Thursday.

BofA’s analysts said that much of the quarterly drop in revenues was due to rising competition from AMD as well as a move to “insourcing” from Apple and Amazon.

Falling gross margins

Intel’s gross margins fell to 55.2% in the first quarter of 2021 compared to 60.6% in the same quarter last year. According to BofA’s analysts, that’s the lowest the firm’s margins have been since 2009.

Arya and his team said that they believe gross margins in the second half of 2021 will be even lower as well, at 55%-55.5%, due to rising depreciation expenses and incremental structural headwinds.

A potentially unprofitable move into semiconductor production

Finally, BofA said that Intel’s move into the foundry business (semiconductor production) is likely to be an expensive and unprofitable transition.

The foundry business is known for having lower margins, and BofA says the company’s limited experience and potential conflicts of interest could lead to poor results.

Intel has also been forced to lower buybacks in order to build infrastructure for its future foundry volumes, creating another headwind to EPS.

The BofA analysts concluded by saying they prefer Intel’s competitor AMD for investors in the coming years.

“We continue to prefer Buy-rated Advanced Micro Devices, which should grow 37% this year and can capitalize on INTC’s process technology missteps and foundry distraction, especially as AMD continues to gain customer share with its own consistent execution and solid pipeline,” the BofA team wrote.

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