Hard-Charging Tech Stocks May Slow for the Rest of 2023, Ned Davis Says

Technology, a sector practically synonymous with momentum investing, has a good record of continuing its strong upward movement for the rest of the year, if it has been barreling upward through July, says a well-regarded research firm. But 2023 may be the exception, the firm, Ned Davis Research, warned in a research paper.

In the three times since 1972 (when Davis started compiling the stats) that the S&P 500’s technology sector had outperformed the index as a whole by 20 percentage points or more through July, there was a strong tech finish for the year, according to the firm’s Rob Anderson, U.S. sector strategist, and Thanh Nguyen, senior quantitative analyst. But in 1995, tech flagged for the rest of the year because of too-high valuations and newfound investor wariness, they observed.

And that 1995 scenario is shaping up to be the case this year, in their report’s estimation: “For now, we are maintaining our March ‘23 overweight of technology based on seasonality, sentiment, and a bullish sector model, but mega-cap weakness and valuations have the sector on a short leash for a downgrade.”

The index finished July up 19.5% and its tech sector was ahead 40%, Anderson and Nguyen wrote. The eight largest S&P stocks, which Davis dubs the Elite Eight (they all happen to be tech-oriented) have fallen 6% from their July 18 collective high, and the rest of the index has been flat.

The paper pointed at Apple and Microsoft, which have the top two largest equity valuations, for their even steeper falls: No. 1 Apple peaked on July 31 and dropped 9.2% through last Friday, while No. 2 Microsoft tumbled 10.6% since its July 8 high.

Meanwhile, investor sentiment has edged downward for tech stocks, per the Hulbert Newsletter, which polls investors. The Davis report stated that Hulbert’s “sentiment composite has fallen into the neutral mode and is at its lowest reading since mid-March.”

The tech sector’s price/earnings ratio is the highest it has been, compared with the S&P 500, since 2004, the paper found. Valuations for the Elite Eight are at their highest since November 2020, amid the market’s snapback recovery from its pandemic swoon.

The sector’s outsized gains previously this year have drawn comparisons to the Internet bubble that popped in 2000, the report noted, adding: “the key difference is that the companies of today are extremely profitable.” And, Anderson and Nguyen wrote, those strong earnings should buoy the tech sector over the long run, but expect some bumps the rest of the year.