Throughout the history of financial markets, there are times when certain groups of stocks appear to be unstoppable.
This is when investors can potentially make life-changing returns and should be fully exposed to the upside that equities have to offer.
On the other hand, there are also periods when nearly everything seems to be working against a sector.
During these times, strong earnings reports are sold relentlessly.
Bad news leads to sharp pullbacks, while good news provides a short-lived opportunity for trapped shareholders to unload positions on the pop.
Sound familiar? This is essentially the market environment that tech investors have been dealing with in 2022.
Although the dramatic reversal in equities last week could lead to a nice short-term rally, the truth is that there are still several headwinds that are likely going to continue weighing down tech stocks going forward.
Until we have more clarity about these issues, the tech sector could continue to be a very volatile area of the market.
If you’re wondering why tech has been so weak this year, here is an overview of some of the headwinds that have been impacting the sector.
Inflation Pressures
It’s no secret that inflation is a major factor that is weighing on investor sentiment in 2022, which is certainly a big reason why technology stocks have taken a beating to start the year.
This headwind is a problem for the tech sector for a few different reasons.
First, it’s important to understand that supply chain constraints are one of the big reasons why inflation has soared.
These constraints have resulted in elevated labor costs and more expensive materials, which means that many high-growth tech companies are facing significant margin pressure.
Also, with the U.S. inflation rate continuing to accelerate and recently hitting 40-year highs, the Federal Reserve is likely to take massive action in the coming months to get the issue under control.
Higher interest rates are on the horizon as central banks aim to tackle the issue head-on, which is bad news for tech companies, especially high-growth businesses.
As interest rates go up, it becomes more expensive for companies to borrow money, which is certainly a problem for businesses that require significant capital to execute their long-term vision.
Scroll to Continue
Additionally, rising interest rates make conservative investments like bonds more intriguing to investors, which could result in more outflows from the tech sector.
It’s also important to note that high-growth companies will take a hit from rising interest rates because they reduce the estimates for these companies’ future earnings.
Economists at JPMorgan Chase are anticipating nine consecutive rate increases, and there’s a good chance tech volatility will persist until we hear more from the Federal Reserve about their timelines for rate hikes.
Questionable Valuations
Another reason why we’ve seen weakness in the tech sector lately has to do with just how stretched many of these company’s valuations got over the last few years.
A lot of the biggest growth stock winners of the pandemic have essentially been cut in half over the last few months as investors began to recognize how overvalued they had become from a fundamental perspective.
Good examples include tech companies like Shopify (SHOP) – Get Shopify, Inc. Class A Report, Roku (ROKU) – Get Roku, Inc. Class A Report, and Crowdstrike Holdings (CRWD) – Get CrowdStrike Holdings, Inc. Class A Report, which are all down 62%, 72%, and 39% from their 52-week highs, respectively.
It helps to review some of the reasons why these stocks ran so much during the pandemic to understand why they are being punished now.
You had unprecedented amounts of liquidity being added to financial markets to keep the economy afloat, which naturally fueled speculation and a “risk-on” approach to investing.
With interest rates kept extremely low for so long, investors looked to generate alpha with riskier assets like some of the tech stocks mentioned above.
There’s also the fact that many young tech companies have been able to easily access capital in the debt and equity markets due to the incredibly low borrowing rates for years.
These narratives are quickly changing, which is providing a reality check for many tech stocks that might have gotten ahead of themselves in terms of their valuations.
How Investors Should Approach Tech Investing in 2022
While there are still plenty of question marks about tech stocks as we move further into 2022, investors that are looking for exposure to the sector could be in for some fantastic long-term buying opportunities going forward.
Many of the tech stocks that have faced heavy selling pressure will need time to find buyers again, but it’s difficult to bet against innovation for the long term.
Also, it’s worth mentioning that a lot of these high-flying tech companies are trading at much more reasonable valuations after their plunges, which makes adding shares more palatable.
Investors that decide to start building positions in disruptive tech names should absolutely be prepared for more volatility at any time, but if you have a long investment horizon it’s hard to pass up remarkable companies at bargain prices.
Another approach might be to look at value tech stocks like Micron Technology (MU) – Get Micron Technology, Inc. Report, HP Inc (HPQ) – Get HP Inc. Report, and Cisco (CSCO) – Get Cisco Systems, Inc. Report, as these types of stocks tend to perform well during periods of high inflation, pay dividends, and are less volatile than other areas of the sector.
Regardless of your approach, one thing’s for sure – 2022 is shaping up to be a fascinating year for tech investing.
