SHARES

Market pullbacks and technology share valuations

Markets have been under pressure for the year to date, but the outlook is not as dire as headlines portray.

2022 is off to a rough start for global markets with the S&P500 and Nasdaq indices declining by 8% and 13% respectively year to date as at January 25 2022. These declines were largely driven by expectations for higher global interest rates as well as geopolitical risks between Russia and Ukraine.

In fact, market pullbacks like these are not uncommon at all. Below is a graph by Morningstar which clearly indicates that we have experienced five similar pullbacks since early 2020 and many more over the long term.

In this case, declines may just be an overdue reset of overvalued markets digesting the impact of higher interest rates going forward. Expectations are still for the economy to grow at a healthy pace this year and, by historical standards, interest rates are still expected to remain well below long-term averages.

High-flying technology stocks have been hit hardest, mostly due to lofty valuations which are unlikely to be justified given future growth expectations. In times of rising interest rates leading to higher discount rates on company valuations, the price paid today becomes increasingly important. This dynamic has led to the highest valuation technology shares being hit hardest.

The below table highlights price drawdowns for several indices and stocks in comparison with their peak valuations in the last three years. The valuation metric used in this instance is a price/sales multiple. Although less common than the price/earnings multiple, several of these technology stocks do not yet generate profits and thus render the price/earnings multiple unsuitable. The price sensitivity to high valuations is clear, especially in times of market distress and a rising interest rate environment.

  Peak valuation 2021 P/S multiple (period 2019-2021) Price drawdown from peak (prices at 25/01/2022)
Low valuation    
S&P500 Index 3.2 9%
Nasdaq 100 Index 5.8 15%
     
Fairly valued    
Alphabet (Google) 9.3 15%
Meta Platforms (Facebook) 9.3 21%
     
High valuation    
Zoom Video Communications 56 74%
Beyond Meat 43 73%
Roku 22 68%
Pinterest 19 69%
Teladoc Health 19 75%
     

Source: Bloomberg

In summary, markets have been under pressure for the year to date, but the outlook is not as dire as headlines portray. Even with growth rates slowing, the US economy is still projected to grow at a healthy rate for 2022 and 2023. As interest rates are set to increase, one must remember that they are coming from historical lows and are still expected to stay low for the significant future according to historical standards. In times like these, it is important to focus on investing in quality companies with reasonable growth forecasts, without having to pay unreasonably lofty valuations.

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Franske Neiteler

PSG Wealth Pretoria-East

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