Heightened inflation fears are threatening to do something to computer and software makers that hasn’t happened in two decades: make them the worst stocks in the market.
They haven’t, however, made them anything close to cheap. With a three-week drubbing of the Nasdaq 100 Index showing no signs of easing up, a few analysts are asking what happens if super-high valuations in companies like Alphabet Inc. and Facebook Inc. revert and drag everything back to average levels?
You almost don’t want to know the answer.
According to Leuthold Group, the S&P 500 Index is at risk of falling 37% should its multiples to sales and earnings return to their mean levels since 1995, a starting point picked to capture a broad upward shift in valuations.
The tech giants known as the Faamgs could face a similar fate, according to Bloomberg Intelligence’s Gina Martin Adams and Michael Casper. In their model, the group’s premium over the market could shrink by another 24% if it goes back to the mean over the seven years before the 2020 pandemic.
To be sure, these calculations are more exercises than predictions, intended to show how stretched prices have become after years of relentless tech gains. Valuations like those explain the market’s hair-trigger volatility lately, as every economic report is combed for its implications on Federal Reserve policy.
It’s a reason Leuthold’s core portfolio this week trimmed its equity holdings by 3 percentage points to 55%.
“With our cap-weighted S&P 500 valuation work looking nearly as extreme as it did at the tech bubble peak, we certainly could have elected to take even more chips off the table,” said Doug Ramsey, Leuthold’s chief investment officer, adding that the firm refrained from turning more bearish because more stocks were participating in the latest advance.
The anxiety created by stretched valuations is on display all over. As surging commodity prices and a tightening labor market sparked concern inflation could persist and force the Federal Reserve to roll back its stimulus sooner than expected, richly-valued technology stocks sold off, driving the Nasdaq 100 toward its worst month since the start of the pandemic in March 2020.
At the same time, the specter of rising interest rates makes elevated multiples harder to justify. A basket of unprofitable tech firms has plunged 37% from its February peak.