As 2021 comes to a close, CNBC looked back at the performance of U.S. stocks this year and found that the tech-heavy Nasdaq Composite Index was up 23% for the year through December 27, trailing the S&P 500, which rose 28%. It was the first time in five years that the Nasdaq has underperformed the S&P 500. Why are tech stocks, investors' favorite stocks last year, starting to fall out of favor? Are U.S. tech stocks on the verge of a sluggish market? Will there be a new round of internet bubble burst? Many investors are entering the new year with these doubts and concerns.
CNBC's analysis points to several reasons for Nasdaq's underperformance this year. One is that tech stock prices have risen so much. In 2020, the Nasdaq climbed 44%, while the S&P 500 rose just 16%. From the end of 2016 to the close of 2020, the Nasdaq was the most well performed every year, rising a total of 139% compared to the S&P 500′s 68% increase. Given that tech stocks have previously outperformed traditional sector stock prices, their current relatively poor performance is justifiable. The seven companies with the heftiest weightings in the S&P 500 — Apple, Microsoft, Alphabet, Amazon, Tesla, Meta, and Nvidia — now make up about 27% of the index. These tech stocks are also the bulkiest members of the Nasdaq, which means that the two indices are becoming increasingly homogeneous. In addition, the fact that energy and real estate stocks led the S&P 500 rally indicates that tech stocks are losing their luster. While it is still too early to talk about the sluggish market for tech stocks amid the current stock market rally, the rally in U.S. tech stocks is slowing. This indicates that the momentum of future growth in tech stocks is waning and their valuations may be approaching an inflection point.
Another reason is the changes brought about by the COVID-19 pandemic. Under the impact of the pandemic last year, many tech companies were boosted by demands for stay-at-home, play-at-home, and work-from-home. However, with the widespread vaccinations and people's lives gradually returning to what they were before the pandemic, the prospects for tech companies are being re-evaluated. This year, supply-chain distortions have led to a surge in shares of companies in the energy sector, thus pushing up the S&P 500 index.
The most important reason is the change in American monetary policy in the face of high inflation. After U.S. inflation hit a nearly 40-year high of 6.8% in November, the Federal Reserve changed its "transitory inflation" stance and accelerated the pace of tapering. This will pose a great threat to tech stocks that rely on future cash flow valuations. This is because tech stocks may be out of favor once expectations of higher interest rates rise. Especially in the case of overvalued tech stocks, such adjustment is more likely to lead to another "Black Christmas" situation triggered by a Fed rate hike in 2018. With this policy trend, the risk to U.S. tech stocks is becoming greater.
Of course, a change in Fed policy is not good news for the U.S. stock market as a whole. In particular, in the context of monetary easing, a large number of U.S. companies have increased leverage in response to the pandemic and market changes. In addition, many companies have used the funds raised to buy back shares to maintain the already rising share price. It is this kind of "self-circular" money cycle that has driven the steady rise of U.S. stocks in recent years. S&P Dow Jones data show that in the third quarter of this year, S&P companies repurchased USD 234.5 billion of stock, a single-quarter repurchase record. Analysts expect stock buybacks by S&P 500 companies to expand further to USD 236 billion in the fourth quarter. According to one study, stock buybacks have contributed to 40% of the S&P 500's bull market gains over the past decade. Among them, tech companies such as Apple, Google parent Alphabet, and Meta Platform have been the biggest buybacks in the first three quarters, with their shares up more than 33%, 67%, and 22%, respectively, so far this year. Apple continues to lead the market in stock buybacks, with its share repurchases totaling USD 63.6 billion over the past three quarters. With the Fed tightening further and possibly raising interest rates sooner than expected, companies listed in U.S. stocks will face pressure from higher funding costs and a shrinking money supply. Under such circumstances, listed companies will face unprecedented challenges in sustaining buybacks and holding up their share prices. If companies are unable to sustain the "self-circular" money cycle, the listed tech companies in the U.S. will face a sluggish market.
Final analysis conclusion:
The slowing growth of the Nasdaq this year suggests that U.S. tech stock valuations are approaching an inflection point. Tech stocks will inevitably take a hit as the Fed tightens monetary policy in the future. These changes indicate that tech stocks are not far from a sluggish market.
