Why this year's tech wreck has changed the game and two stocks for the new world order

Given the overarching macro conditions, which are punctuated by high inflation, higher interest rates, and slowing economic growth, I put it to Ruiz that things could potentially get worse before they get better for tech.

In response, Ruiz notes that predicting short-term moves in tech, one of the traditionally fastest-growing sectors, will remain challenging as the market remains fixated on inflation and central bank policy. He goes on to comment:

“Unless we see inflation brake (this month’s US print was more a “crack”) and central banks revert to the liquidity playbook, this is a market where investors, in our view, should be searching for well-capitalised businesses situated in strong end markets with resilient fundamentals.”

Even more profoundly – and in direct answer to one of the key questions in the introduction about whether US tech stocks can return to their former glory – Ruiz had the following to say:

“As central banks drain the enormous COVID era liquidity from the system, it’s unlikely we see a sustained valuation re-rating back to 2021 levels. Underscoring how unique this period was, the S&P 500 IT index’s forward P/E traded to 29x at its COVID peak, a level it hadn’t come close to since the tech wreck aftermath in 2003 (Fig 3). 

What is the opportunity for investors?

On this, Ruiz is very clear, saying that investors should ask themselves which businesses can maintain outsized profitable growth and how much we should pay for these businesses as the economy moves in the wrong direction.

Ruiz notes that historically, investors have fared well by blindly buying the collective mix of tech giants, whose collective size dominated various indices. 

As of 31 Dec 21, the MSCI USA Index’s seven largest companies were tech equivalents, collectively representing 25.5% of that index.

Those days are over, however, and from this point, their performance is likely to diverge. "In our view, it is important to assess these companies individually on:

• Valuation;
• How effectively they are investing in growth initiatives;
• The levers they could pull to create value;
• The extent to which they are returning capital to investors; and
• The sensitivity to an economic slowdown and ability/willingness to protect margins via cost-cutting”.

Noting a host of problems at major players like Alphabet, Meta and Amazon, Ruiz suggests that “the opportunity in the near-term, therefore, may be further down the market cap spectrum and require investors to look more broadly than just the US’s largest tech companies, or the US at all.”

He highlights that with a fast-changing opportunity set, T.Rowe Price is looking globally and are interested in companies where they can find a true moat surrounding their business and evidence of likely resilience in a weakening macro environment.

Ruiz highlights Dutch company ASML (NASDAQ: ASML) as one such example, noting that it is the world’s sole supplier of equipment required to manufacture leading-edge semiconductors.

“Despite the recent rally, the company remains reasonably valued with a two-year view and maintains a solid backlog of customer demand,” says Ruiz.

Ruiz further adds that T.Rowe Price is interested in companies with proven growth but where the market has overreacted and led to a mispricing of the future opportunity.

He highlights Nu Holdings (NYSE: NU) in Brazil – which the team views as one of the world’s leading Fintechs - as one such stock, believing this year’s selloff provides investors with an attractive entry point to a LATAM banking market disruptor. 

“The company has grown its customer base to more than 70 million since launching in 2013 and has the ability to grow revenues more than 50% p.a. in the foreseeable future, fast-tracking their profitability ramp and experiencing greater than expected operating leverage,” says Ruiz.

The final word

Wrapping things up succinctly, Ruiz comments that “investors need to be cautious and selective in the near-term, but also acknowledge there is a season for everything. 

"Long term, we believe some of the powerful trends that have driven outsized growth remain intact and should continue to present solid medium to long-term opportunities.”

Ruiz adds that e-commerce, cloud computing, electric vehicles, machine learning, and quantum computing, are some of the powerful trends that T. Rowe Price expect to continue over the next decade and should not be dismissed.

Ultimately, and as always, “investors should carefully consider their investment horizon, increase their focus on valuation and be mindful of the likely volatility as we navigate choppier economic waters over the months ahead. There will still be opportunities, but the “free kicks” from cheap money are gone (for now).”

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