Tech megacaps such as Microsoft Corp. and Apple Inc. are examples of how sentiment may be shifting. Both saw mediocre share reactions to strong earnings reports.
While the Faamg group has seen its price-earnings multiple shrink from its peak, it still fetches a 24% premium relative to the rest of the S&P 500. That compared with a P/E spread of just 7.3% five years ago, according to data compiled by Bloomberg Intelligence.
“The Faamg bubble is deflating and should continue to do so as risk-tolerance heals and investors position for sustainable recovery,” said Martin Adams at Bloomberg Intelligence. “Valuations have dropped, but there is room for the group’s premium to fall.”
For years, one pillar of support for equity valuations has been the rock-bottom interest rates that the Fed put in place to spur growth. Now, as the economy reopens, many investors see the only path for rates is up. That’s a problem, because relative to bonds, stocks are already less attractive than any time in a decade.
Based on a methodology sometimes called the Fed model, the S&P 500’s earnings yield—how much profits you get relative to share prices—is about 1.7 percentage points above the yield on the 10-year Treasuries. That’s close to the smallest advantage since 2010. Should 10-year yield climb to 2%, the S&P 500 would have to fall by 8% to keep the equilibrium, all else equal. The 10-year yield recently sat near 1.7%.
Valuations are never a great timing tool as expensive stocks can get even more expensive. Yet for many tech stocks, the recent rout hasn’t made them cheap and yet the momentum is turning against them.
“We would like to buy tech—we think it’s fundamentally a great sector—but we need to buy it at more attractive prices,” said Kevin Caron, portfolio manager for Washington Crossing. “We may have reached the point where momentum can only take the group so far, and we are now pushing up against the limits of valuations. It’s hard to say it’s fully been washed out.”
—With assistance from Claire Ballentine.
This article was provided by Bloomberg News.