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.

Read the original article on Business Insider