Technology stocks tend to lead the entire market. The built-in volatility due to innovation and heavy competition makes the sector the ideal barometer for the rest of the stock market.
Dangers are increasing for the tech sector and may be signaling a longer-term decline in the overall stock market.
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I have identified five pending dangers for the tech sector. While each of these factors can be overlooked, together they paint a very bearish picture.
1. Declining P/E Ratios
Price-Earnings, or P/E, ratios are used to forecast what investors are expecting in the future -- the higher the P/E ratio, the higher the anticipated future growth. Technology stocks have experienced an overall sharp drop in P/E ratios over the last month. In fact, the reduction could be considered dramatic.
In the last month, the S&P 500 information-technology sector has fallen over 11% with future P/E ratios based on consensus earnings estimates plunging lower. Examples include Amazon's (Nasdaq: AMZN) P/E ratio falling from 98 to 65 and Netflix's dropping from close to 112 to 85 during this time fame.
Falling P/E ratios is a scary signal for the tech sector if not for the entire stock market.
2. Buyback Plunge
Confident companies often buy back their shares when they are optimistic about the future and have plenty of cash.
MarketWatch recently published a study by Michael Schoonover, COO and portfolio manager of Catalyst Funds, revealing a considerable plunge in tech share buybacks in October.
Schoonover's work indicates that year-to-date the monthly average of buybacks through September was over $36 billion for the tech sector. However, October's average precipitously plunged to $1.7 billion!
He told MarketWatch, "The [buyback] drop is significant not merely in numbers, but also as we enter a period of increased uncertainty. Investors should continue to monitor the buyback activity of technology companies as an indication if the companies continue to see a lack of opportunity in their own stocks."
The buyback plunge could efficiently be signaling dire times ahead for the tech sector, as well as the entire market.
The Chinese tariffs are truly the wild card in the tech sector's future. The reason it remains unknown is the fickle nature of the Trump administration. No one really knows how long the tariffs will last, how large they will become, and what exactly will be the effects both in the short and long term.
Recently, $200 billion of products from China were slapped with tariffs. Just for perspective, China manufactures 60% of the world's smartphones and a massive percentage of all computers. These large percentages can result in bringing down the entire sector.
Add in the "spy chip" scandal arising from China and a very uncertain picture is painted for future gains in the tech sector. More observation is needed to clarify at this time.
4. Climbing Interest Rates
I have long preached that rising interest rates really don't matter as long the increase is gradual and signaled well in advance. However, there are ways that climbing rates can adversely affect the tech sector.
First, it is important to note that the monster tech companies with massive cash reserves are less likely to be affected than the smaller, scrappier firms. The reason for this is that rising rates affect the debt markets, and the large cash holdings of the big firms significantly reduce the need to access debt for growth.
However, many of the second- and third-tier tech names depend on low-cost debt to operate. These firms could quickly feel the bite of higher rates over time.
All tech firms may suffer tangentially from higher rates. Higher rates can reduce revenues thanks to the trickle-down effect. Consumers may spend less on the company's products and services due to higher interest.
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5. Decelerating Economy
The economy may soon decelerate thanks to the Fed tightening of accommodative policy. Semiconductor firms generally suffer the greatest from a slowing economy.
It is not just the U.S. economy that causes concern. Due to the international nature of tech firms, global slowdowns can have an adverse effect on the sector.
Risks To Consider: The famous saying that markets can remain irrational longer than you can stay solvent fits perfectly with today's tech sector. Just because things start to signal bearishness does not mean that tech stocks will move lower.
Action To Take: Consider lightening your tech holdings in the face of the above.