Tech stocks started the year on a roll driven by expectations that the US Federal Reserve will go slow on interest rate hikes. The hype over artificial intelligence also fuelled the rally, resulting in the tech-heavy Nasdaq index rallying by more than 40% at some point. Fast forward, the momentum has faded, and the index has posted its biggest loss for the year, raising serious concerns in the market.
Market Correction
The Nasdaq Index fell by about 4.8% in September, signaling a buildup in selling pressure among tech stocks. Following the deep pullback, strategists at Goldman Sachs believe tech stocks could be about to turn the corner. The deep correction has essentially led to cheap valuations at a time when earning estimates are still rising amid solid underlying fundamentals.
Following the deep correction, the price/ earnings to growth ratio (PEG), which calculates price relative to earnings and long-term growth, has shrunk to 1.3 on the Nasdaq index. In contrast, the PEG median on the S&P 500 stock stands at 1.9. For the Nasdaq, it is the largest discount in nearly six years. The level has only been recorded five times in the last decade.
The cheap valuations could act as an opportunity for investors who missed out on the initial move higher to join the rally train. In a research note to investors, Goldman Strategists Cormac Conner and David Costing reiterated the divergence between falling valuations and improving fundamentals presents a tremendous opportunity for investors.
Earnings Boost
The focus now turns to third-quarter earnings that could act as a catalyst to trigger a bounce back after the recent correction. Expectations are high around tech stocks delivering better-than-expected results on the back of solid fundamentals in the third quarter. Profit upgrades among the tech stocks continue to outnumber downgrades, which should offer more support to potential bouncebacks.
Analysts are projecting technology stocks to post earnings growth in the upwards of 4.3%. The strategists are also confident of sector performance during the reporting season, given that the largest tech stocks have always outperformed the S&P 500 by more than 60% since 2016.
Likewise, the strategists are confident of US stocks even though they have come under pressure in the aftermath of the FED remaining hawkish. Stocks have pulled back significantly, having become clear the FED is not planning to cut interest rates anytime soon. With the high-interest rate environment, there have been growing concerns that access to cheap capital will be difficult, which could fuel the recession prospects.
Market Outlook
Nevertheless, the Goldman strategists are confident of the Nasdaq 100 finishing the year at 4,500, representing a 5% gain from current levels. Consequently, the index will recoup all the losses accrued last year when it fell by 19.4%. The strategist is also bullish about further upside over the next 12 months on the US economy, avoiding a deep recession.
On the other hand, strategists at RBC Capital Markets led by Lori Calvasina expect weakness in US stocks to continue after the recent correction. According to the analysts, there is room for investors to be more pessimistic, given that the AAII Investor Sentiment Survey, which measures net bullishness, has dropped sharply since mid-August.
