Technology Outperformance No Longer Supported By Fundamentals

Source: Morgan Stanley

A word of caution from Morgan Stanley’s equity strategists:

« The latest burst of Tech outperformance has not been accompanied by superior EPS trends. Just now Tech shows few signs of stopping (or even slowing); for example: i) post its largest 1m outperformance versus the S&P since 2012, the NASDAQ is now 2.7SD above its 12M relative average; ii) 80% of constituents of MSCI ACWI’s IT index outperformed the market over the last month, the highest breadth reading since 2003. Amid all this euphoria we’d encourage investors to keep a close eye on EPS trends as the latest burst of price outperformance has not been accompanied by EPS outperformance. »

It seems investors have started noticing.

According to a recent review of fund managers portfolio positioning done by BofAML’s quant strategy team, « in February, funds reduced overweight positions in Tech and Consumer Discretionary while increasing exposure to Financials. »

In aggregate, funds reduced position by $40 billion, while « strong macro and earnings data support rotation towards cyclicals. »

Europe Technology ?

With €447 bn of cumulated market cap as of March 16, 2018, Europe tech sector looks pale in comparison with its US counterpart

Source: Stoxx, 16 March 2018

 

Like its US counterpart, the European tech sector has been performing handsomely over the last few years.

Stoxx Europe 600 Technology (SX8P) Price History

Source: Bloomberg

Stoxx Europe 600 Technology (SX8P) EPS & P/E History

Source: Bloomberg

The above graphs tend to give a false impression of « everything’s going fine in Europe ». Well, that’s not entirely true.

YTD (as of March 13), European technology stocks were up 4.6%. Contribution from P/E was 4.9% and the one from EPS was -0.3%… Not a very reassuring trend.

Currently the sector trades on a P/E multiple of 21.3x according to Bloomberg estimates and a P/B of 3.3x.

In 2017, the SX8P index grew 19.3% of which 5.2% came from P/E multiple expansion and 13.4% from earnings growth/revisions.

2018 outperformance of the sector looks less sound than the one observed in 2017, which justifies some caution going forward.