appledesign
2022 was not kind to the technology sector as evidenced by the Innovation Select Sector SPDR ® Fund (NYSEARCA: XLK) being down over 28%. Compared to the S&P 500 down simply over 19%, leaving out dividends, the underperformance was product. The fund tracks the innovation companies within the S&P 500 index, which account for over 26% of its overall worth.
Innovation is by far the biggest sector weighting in the S&P 500, the next being healthcare at simply under 16%. Provided its dominance in the US market indices, the outlook for the technology sector handles added value.
This is especially so as the opportunity expenses in innovation during 2022 were considerable compared to most of the other sectors. The following table displays the efficiency of each of the eleven main sectors within the S&P 500 index through mid December 2022 using the SPDR S&P 500 ® ETF Trust (NYSE: SPY) as the proxy. It was compiled using data from State Street, its sector funds, and closing rates since December 18, 2022. Using year end 2022 rates would change the data little.
Source: State Street. Developed by Brian Kapp, stoxdox
The innovation sector and the S&P 500 are highlighted in yellow for ease of contrast. Taking a look at appraisals, technology is tied with consumer staples for the greatest valuation, near 21.5 x next year’s estimates for a 4.7% profits yield. I leave out real estate as PE is not the appropriate assessment metric for this group.
The opportunity cost is evidenced by the energy sector, which is highlighted in blue. I covered the favorable outlook and probability of ongoing outperformance by the energy sector in a report, “Relative chances in energy for 2023.”
Offered the small weighting in the market indices at under 5%, energy sector outperformance has gone unnoticed for market cap-weighted investment portfolios. Beyond energy, the sector outperformance includes 4 of the eleven being down 7% or less.
Technology Sector: The Big 2
With the innovation sector controling the indices, it is notable that the sector is heavily weighted to simply two companies. Apple (NASDAQ: AAPL) and Microsoft (NASDAQ: MSFT) together account for 44% of the total sector worth. As an outcome, the outlook for the sector is mostly connected to its 2 largest business when using a market capitalization-weighted technique, such as the XLK. For greater context, the top 10 companies and their weightings in the sector are shown listed below.
Source: State Street. Produced by Brian Kapp, stoxdox
One may be amazed to see Visa (NYSE: V) and Mastercard (NYSE: MA) in the top five list of the technology sector. Each is valued at a considerable premium to the market at 25x and 30x next year’s price quotes, respectively. Nvidia (NASDAQ: NVDA) is valued at 42x. Rounding out the top five highlights the evaluation maturity of the sector, particularly considering the intermediate-term outlook.
Consensus Estimates
The following table displays consensus revenues price quotes for Microsoft and Apple through mid-decade. The information was compiled from Looking for Alpha. I have actually highlighted the present fiscal year in yellow.
Source: Looking For Alpha. Produced by Brian Kapp, stoxdox
In essence, growth rates are no longer exceptional while valuations are still well above the market. It is tough to be especially bearish on the 2, as the majority of would concur that Apple and Microsoft are premium business. That stated, the marketplaces are undergoing a phase change which features an expanding chance set. The following agreement projections for Schlumberger from my report “Is the sun setting on energy stocks?” provides a glance into the progressively competitive sector opportunities.
Source: Looking For Alpha. Created by Brian Kapp, stoxdox
Compared to Apple and Microsoft, Schlumberger looks like a dynamic growth business into mid-decade. Another example in the energy sector, from the September 7 report “CNX Resources: The Saudi Arabia Of Natural Gas,” highlights the variety of the opportunity set.
Source: Looking For Alpha. Produced by Brian Kapp, stoxdox
The energy examples light up the varied opportunities readily available to financiers as we traverse the current phase change in the markets. The following quote from Oaktree’s Co-Chairman Howard Mark’s December 13 financier letter, “Total change,” provides his 53 years of experience and context for evaluating the relative attractiveness these days’s chance set.
… the environment is and might continue to be very different from what it was over the last 13 years– and the majority of the last 40 years … financial investment strategies that worked best over those periods may not be the ones that outshine in the years ahead.
The Drought
A defining feature of market cycles is sector management modifications. The largest bull market in history ended in January 2022 and it was led by the innovation sector. From a cycle point of view, it would be unusual and even abnormal for the innovation sector to lead the next cycle. While qualitative in nature, there is factor to think that the sector will face relative headwinds.
There are lots of resemblances in between the just recently ended tech-led cycle and that which culminated in the 2000 dotcom peak. One such resemblance that may be underappreciated today is the high-powered nature of capital flows in the tech sector in each instance.
The following table shows the approximated worth of funds raised by means of IPOs over the last few years, omitting SPACs and other non-operating business. Keep in mind that the 2016 through 2019 data was compiled from Jay R. Ritter, and the 2020 through 2022 information was put together from FactSet and Nasdaq.
Created by Brian Kapp, stoxdox
I have actually highlighted 2020 and 2021 in blue, in which a combined $238 billion was raised. While it is unknowable, a product quantity of this capital most likely found its way into technology spending plans. This is particularly true offered the nature of the IPO market throughout the 2020 and 2021 duration. For example, business like Airbnb (NASDAQ: ABNB), Palantir (NYSE: PLTR), and Coinbase (NASDAQ: COIN) invest most heavily in innovation.
Notification that capital flows have actually all but vaporized in 2022, which is highlighted in yellow. This collapse alone may suffice to cause product downside surprises throughout the innovation sector as 2023 unfolds. Innovation budgets in 2021 and 2022 were set against the background of a $238 billion capital influx from the IPO market alone. The feed through to technology costs was most likely considerable.
Technology spending plans for 2023 and into 2024 will be set against a background of $7 billion raised from the IPO market year-to-date in 2022. A comparable contraction can be found across the broad capital markets, consisting of high declines in equity capital, private equity, and the bond market generally.
The contraction in capital markets is happening in sync with an unfolding recessionary backdrop for the broad economy. This will put additional pressure on technology budget plans as profits are coming under increasing pressure. I covered the unfolding recessionary environment in the following reports:
- “FedEx and the economic downturn”
- “The recession is here, filter the noise”
Offered the unfavorable macro-economic advancements checking out 2023, the rapid development rate of innovation budgets in 2020 and 2021 creates an increased risk of unfavorable surprises. A cursory glance at capital investment by Meta (NASDAQ: META) and Amazon (NASDAQ: AMZN) records the scale of the recent investment cycle.
Compared to its 2019 capex level of just under $17 billion, Amazon’s capital investment during 2020, 2021, and 2022 are remarkable in comparison. Amazon’s capex came in at $40 billion, $61 billion, and $59 billion (Q3 2022 tracking twelve months) for each year, respectively. The boost over 2019 for each of the past 3 years has actually been 138%, 262%, and 250%. It is reasonable to anticipate a material deceleration or decrease in the coming years.
Meta’s investment development has actually likewise been extraordinary, though less than Amazon’s. The company’s capital investment in 2022 are on track to reach $30 billion compared to $15 billion in 2019, a 100% increase. Amazon and Meta are just 2 companies which together are investing nearly $60 billion more on capex yearly compared to 2019. Furthermore, these costs patterns are broadly representative of market patterns.
When the capital market collapse is combined with recessionary conditions and elevated innovation spending given that 2019, there is an increased threat of downside surprises. The market may be signaling that this danger is most likely to emerge as 2023 unfolds. Evidence is on screen in the following performance table from earlier which now consists of “% Off Low” and “Low Date” columns.
Source: State Street. Created by Brian Kapp, stoxdox
The low date is the low rate reached during 2022, omitting energy for which it is the current correction low provided it is greater year-to-date. I have actually highlighted in yellow the weakest sectors coming off the 2022 bottom. Offered the big year-to-date declines for these sectors (the % YTD column), the weakness of the bounce is a bearish signal getting in 2023. It deserves noting that January is known for technical bounces as tax loss selling eases off. Regardless, the message of the market is not bullish.
I have highlighted in blue the two sectors that bottomed first in the mid-year timeframe (Low Date). These are by meaning leaders in the existing cycle. Of note, highlighted in blue, industrials and products bottomed prior to the staying 7 sectors, while surpassing materially. This indicates possible leadership for these sectors looking into 2023.
As a result, I will cover the outlook for the materials and industrial sectors in coming updates. The sectors use an appealing opportunity set as covered in the following reports:
- “Gold is on the efficient frontier”
- “Eastman Chemical is going into a booming market”
- “Leading commodities for the energy shift”
- “Freeport McMoRan, Physician Copper makes a house call”
- “Rio Tinto is a perfect portfolio diversifier”
Technicals
With the technology sector underperforming and lagging severely off the 2022 lows, the technical backdrop remains quite bearish. The well-defined sag is plainly visible on the following 1-year day-to-day chart. Note that the green line represents a crucial technical support level, while the gold line is the 50-period moving typical and the grey line is the 200-period moving average.
Innovation Select Sector SPDR ® Fund XLK 1-year day-to-day chart. Produced by Brian Kapp utilizing a chart from Barchart.com
Notice that the XLK has actually been declined at the 200-day moving average on three separate occasions throughout 2022. This is textbook bearishness price behavior. Surprisingly, the drawback momentum ended in June 2022, followed by a choppy trading range which saw marginal new lows in October. The 5-year weekly chart below offers added context for the drop.
Technology Select Sector SPDR ® Fund XLK 5-year weekly chart. Produced by Brian Kapp utilizing a chart from Barchart.com
Notice that the XLK is presently evaluating support at the upper assistance level (leading green line) near $120. This occurs to accompany the 200-week moving average (the grey line). The next assistance level is 20% lower near $100 per share, which is also the pre-COVID top. With the weak point of the current bounce and the tough outlook into 2023, this level could be checked.
The lower support level near $80 was resistance during 2019 and can not be dismissed. The zone was damaged throughout the COVID lows of March 2020. The following 20-year monthly chart places all 3 support levels into historic context.
Technology Select Sector SPDR ® Fund XLK 20-year regular monthly chart. Created by Brian Kapp using a chart from Barchart.com
On the left side of the chart, notification that the technology sector traded considerably below its 50-month moving average (the gold line) following the 2000 dotcom top. The sector did not sustainably trade above the 50-month moving average again till 2012. This works as a reminder of the time measurement possibilities and not as a forecast.
Technically speaking, the XLK stays in a sag.
Summary
The bearish technicals, heightened growth unpredictability, and premium assessments combine to create a neutral risk/reward circumstance. From a portfolio perspective, the market cap-weighted innovation sector is fairly unsightly compared to others. Like the energy sector, a more equal-weighted or active portfolio strategy is likely to offer a greater risk/reward opportunity over the intermediate term.