Fidelity: Tech Stocks Can Keep ‘Climbing the Wall of Worry’

That seems to be like the math right now. And the calculus is, is, um, earnings valuations. And you've been writing a lot about that since July. Really. Where are we at? Yeah, it's fairly rare to see a 30% multiple contraction over any year. I mean, when you look from 1990, the technology sector has only experienced that less than 5% of the time. And the interesting part you highlighted, you know, the stock market is a discounting mechanism. And technology stocks have a very clear relationship. When you look through the data, the bigger the multiple contraction. And now they're only trading at a 10% premium to the S&P 500, which is in the bottom quartile of their historical range since the 60s. When you see that, it actually skews your risk reward, meaning the bigger the multiple correction, the more likely the stocks are to outperform. That is even true if earnings decline. Right. So if you look at any time you've seen multiple corrections like this, it's actually most of the time is on strong earnings. So the biggest question I get is that yes but they should be cheap if we are seeing peak earnings. And there's some truth to that. So all peak earnings usually have multiple contractions. The question is, is our multiple contraction reflective of peak earnings? When you look back historically 77% of the time earnings do continue to grow after the multiple correction we've seen. And in that instance very strong odds of outperformance. But you even get strong odds of outperformance in the 70 percentile range, even if earnings decline, which is kind of a long winded, quantitative way of saying, look, whatever you're afraid of in terms of CapEx, ROI, is there too much spend? Is the declining free cash flow going to be persistent? A lot of that might be priced into the stocks. Uh, the long winded quantitative answer is why I love to have you in the show then is don't don't worry about that. I want to bring back the table that that I showed at the start of our conversation, because it was fresh on the Bloomberg this morning. So this is the Z-score, right? The table calculates the Z-score forward price to earnings ratios for the main S&P 500 sectors. And then it uses weekly data with a five year look back in. The main point is that tech has the largest D rating right relative to its five year norm, but that is ahead of earnings. That's why we're talking. And there are strong fundamentals. So everyone's expectation is you can you see outperformance in tech going forward. Um is that what you see? Certainly the risk reward is skewed once you see that multiple correction I mean that is usually a better signal than some noise. Right. So the market almost always gets it right from that perspective in that earnings do continue to grow. And that valuation support has more often than not actually priced in a fair amount of bad news. So it's kind of akin to saying that the technology sector can still climb the wall of worry. Right. And I think that that's true for the overall U.S. stock market. But I think technology looks more like leadership when you look at the valuation data and the consistency of earnings through time, even when you look at the government data in terms of CapEx, spending and technology, and they do break it out. We even have data centers going back to 2020. When you look at it, yes, it's slowing from a second derivative perspective. And that was even on the juniper counter, the GDP data. And it's probably going to slow down further. And some equity investors would say, oh, well the second derivative slowdown is here. That has not really been a problem for the stocks historically, because the vast majority of slowdowns in tech CapEx, because it's been a secular trend, don't end in a contraction. And in fact, the better the starting point, even in a slowdown, the more likely technology stocks have been to outperform, which kind of gets back to the by the time you see the data, the stocks might have already discounted it historically. You are talking about and you've been writing about how important tech spending has become to the US economy. And in that answer, you're kind of speaking to what happens if that spending would slow down. What are some of the headwinds, um, in your models for the tech sector? Right. What would what is something that would would facilitate a slowdown in their spending? I mean, you're already seeing the slowdown. So I don't even think we have to say whether or not it's going to slow. It's here in the accounts already. Again, I think you see a secular trend from technology spending or CapEx being 3% of GDP back in the 60s to now in excess of 7% now. So people would say that that's elevated and we are dependent on tech CapEx. And the interesting part is, look, you can always argue that it's going to be different this time, but we have all this historical data and you can see one. This trend is very secular, unlike residential investment, which kind of got us into the crosshairs in the financial crisis. But two is that slowdowns don't usually end in a contraction. There's only been four contractions the financial crisis, the.com bubble, and then two recessions in the 70s. That's how strong the secular trend is. Now, the interesting part is let's just assume that it slows from here, which again, we are already seeing that in the data. Then you can say all right, let's let's assess the dependency of the U.S. economy on this secular trend. And what you find is that when you see the slowdown, usually technology, usually CapEx and GDP growth for the rest of the sectors actually accelerate, which almost tells you what I think we kind of know as investors is that CapEx is more often than not, which is not to say every time a leading indicator for the U.S. economy. So as much as we might want to, we are afraid of the fact that the U.S. economy is dependent on technology CapEx. It might actually be signaling future growth.