London View

Tech Stocks Rebound On Wall Street But Worries Remain

Wall Street’s rally Tuesday inspired most Asian bourses overnight, lifting European equities early Wednesday. US stocks rebounded in the previous session following three-consecutive days of losses – the S&P500 rose 0.4% to snap its three-day losing streak and more encouragingly, the tech-heavy Nasdaq index gained 0.8% after the index took a beating amid panic in the market over inflated valuations in the tech sector. Shares in Amazon, Facebook, Netflix, Google and LinkedIn all stabilised after being caught in the rout in US stocks.

That said, it would be unwise to say concerns about the stretched valuations in the tech space have eased – yesterday’s price-action appears to be value-hunters snapping up stocks on the dip. Big name US tech stocks are on astronomically high valuations with forward P/Es from the likes of Amazon at 547x, Facebook at 94x and Netflix at 160x – during the past few years, the low interest rate environment and waves of stimulus by the Federal Reserve gave over-zealous investors with an insatiable hunger for growth-focused [or momentum stocks] high-beta stocks to pile into the sector.

Investors jumped on tech stocks with compelling earnings growth prospects and innovative revenue streams in a race to buy into the next “Apple” or “Google” – this led a wave of high profile tech IPOs like Facebook, LinkedIn, Twitter. Tech companies which went public took advantage of the market conditions and the frenzy built up around their outlooks which fuelled the ballooning valuations.  Investment banks fuelled the hype, booking hefty IPO fees for their part in helping to get tech companies to market – money managers indulged in the tech sector, buying high-beta momentum stocks for clients who all wanted to have a piece of that pie.

So, the correction in the tech stocks in recent sessions appears to be completely valid and healthy – it will go some way in flushing out the speculative bets and force investors to be a little more mindful about the US tech sector’s prospects, particularly now as we kick off the Q1 earnings season in the US. Poor earnings from tech companies will certainly now be amplified and valuations will again come under intense scrutiny – for that reason, expect further turbulence for the global tech sector.

Staying on US earnings season, Alcoa kicked off the proceedings after the US closing bell by reporting better than expected results which lifted the share price – encouragingly, Alcoa provided an optimistic aluminium market outlook. This week, we will see the release of bank earnings form JPMorgan and Wells Fargo – Citigroup Tuesday dampened the mood around the banking sector by warning on profits due to litigation costs.

Back in Europe, although the mood is largely upbeat with traders encouraged by the overnight price action in the US and for most Asian indices, the geopolitical tensions continue to curb upside momentum. The US accused Russia of fuelling unrest in the Ukraine as pro Russian rebels seized control of government buildings in three Ukrainian cities – the US warned that Russia was creating a pretext for military action by failing to destabilise the situation. This raises fresh concerns about military action by the US which could knock the wind out of the global economy.

Over in Japan, the Nikkei 225 index declined 1.7%, dropping for the third straight day on the back of remarks from Bank of Japan governor Kuroda who reckons the increase in the Japanese sales tax rate will eat away at economic growth this quarter but a rebound for the economy is expected in Summer 2014, essentially saying he does not think further stimulus measures are needed. That led to traders dumping Japanese equities in favour for the safe-haven yen; across other currency pairs, the USD a little firmer and euro steady. Gold futures up a touch while oil prices ease; core government bonds such as UK gilts and German bunds are softer as sentiment is still risk-on. Looking ahead, we have the FOMC meeting minutes which are likely to provide further clues over the Fed’s thinking regarding monetary tightening.