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What the massive selloff in US tech stocks teaches us about investing

This US stock market index is the most widely tracked measure of tech stock prices. 

Tech stocks have been the leaders of the rally in global stock markets since March 2020. In just 20 months, the NASDAQ Composite soared from 7,000 to 16,000. 

Major tech stocks delivered multibagger returns over 2020-2021.

But the situation has completely changed this year. Tech stocks have been the leaders of the market decline. Most US tech stocks are down. Many are down more that the index. Some have lost more than 50% of their marketcap.

Well-known, highly popular stocks like DocuSign (-79%), Etsy (-75%), Moderna (-75%), PayPal (-75%), Netflix (-74%), and Zoom Video Communications (-74%), have been the biggest losers.

And what about the biggest tech stocks?

Well, from their all-time highs, Apple is down 25%, Goggle is down 28%, Amazon is down 41%, Nvidia is down 50%, and Meta (parent of Facebook) is down 59%.

These are massive declines. And there could be more declines in store.

In the latest earnings calls, the management of these firms have warned of declines in revenues and profits. This only adds to the concerns about a slowdown in their growth that is already underway.

Also, the latest investments made by these firms in futuristic areas like Artificial Intelligence, metaverse and the like are still unproven. Revenues and profits could take years to scale up to a significant level.

Then there are other issues like the business disruptions caused by the Russia-Ukraine war and the global semiconductor shortage which is likely to extend well into 2023.

The latest concerns of investors include soaring inflation, rising interest rates, and declining consumer spending. These are all reasons for the stock market fall.

To add to this there is fear in the market of the US economy dipping into a recession. In fact some market gurus believe the US is already in a recession.

The US economy contracted in the January-March quarter. A recession is defined as two consecutive quarters of declining GDP growth. Thus, if the April-June quarter’s GDP growth number (to be announced at the end of July) is also negative, it would confirm the US is in a recession.

This would be extremely bearish news for tech stocks which have already fallen into a bear market. It’s no wonder investors don’t want to touch these stocks.

So what can we learn from this debacle?

· What goes up must come down

2022 will be remembered as the year investors woke up to the fact that markets don’t go up in a straight line.

If an asset has risen far is excess of its fundamentals, then the likelihood of a crash is high. The only question is the timing of the correction.

2020 and 2021 were historic years for tech stocks. The tech rally brought back memories of the tech boom of the 1990s. But there was a difference this time.

You see, back in the 1990s technology as a sector was not a huge part of the benchmark indices in the US. This time around they were the backbone of the market. Not only were the stocks large in terms of marketcap, but they were also outperforming.

This meant that most ordinary investors had already jumped onboard this rally and were profiting from it. They were hit hard when the momentum in these stocks reversed.

This brings us to the next lesson.

· Size is no guarantee of safety

It’s natural for investors to think of large bluechip stocks as safe haven investments. But when these stocks are also delivering great returns, the temptation can be overwhelming.

Why bother doing any research or due diligence when the companies are dominant in their market and well-understood by analysts?

Retail investors thought they could not go wrong as they were buying large stable tech companies which were changing the world.

That is not a smart way to invest. Profits for an investor is not assured in a largecap even if it’s widely held and is a favourite of the market. Just look at Amazon and Tesla.

· The hottest stock may not be the best stock

A big reason for the huge rise in tech stocks was that they had a good story to tell.

They wanted everyone to believe they were changing the world. Thus, the potential growth in revenues was unlimited.

It was a good story and it helped to drive their share prices higher.

But the problem with story driven stocks is that if the story changes, the stocks crash. Even worse, the company’s story doesn’t need to change for the stock to crash. A change in the market sentiment is enough.

Just look at Amazon. Its business hasn’t changed in 2022. The story is unchanged. But the stock has crashed because the market sentiment has changed. And when that happens the stocks that went up the most are the ones that fall the most.

So in the long-term, the hottest stocks may not be the best…even if the business lives up to expectations. This is an important lesson to remember.

· Interest rates matter

The risk-free interest rate is like the force of gravity in the stock market. The higher it goes, the harder it is for stock prices to go up.

And the most important interest rate of all is the yield on the 10-year US government bond. It has been rising steadily since last year. It was only a matter of time before the smart money turned cautious.

This is also the reason why foreign investors have been selling Indian stocks since mid-2021. They knew interest rates were going to up due to high inflation and that would mean lower stock prices.

And the stocks that would be hit hardest would be the ones trading at high valuations. In this case, tech stocks.

Keep these lessons in mind. Investors who learn these lessons will have an edge over those who don’t.

Happy investing!

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such. 

This article is syndicated from Equitymaster.com

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