Tech thrashing long overdue

Tech stocks sporting sky-high valuations have been hammered of late, the Nasdaq recently suffering its worst three-day losses since November 2011.

The Nasdaq's 7 per cent pullback doesn't capture the true scale of the bleeding. Twitter is more than 40 per cent below its high. LinkedIn fell more than 20 per cent in a fortnight, as did Facebook, before both stocks rebounded somewhat late last week.

Amazon hit a low of $313 last week, almost a quarter below its January peak of $408, while other momentum stocks such as electric car maker Tesla as well as the entire biotech sector have also been pounded.

About time too. The Nasdaq 100 stocks that suffered the biggest declines had rallied an average of 134 per cent last year, according to Bespoke Investment Group.

Bloomberg notes the Nasdaq Composite Index trades on 32 times trailing earnings, compared to 17 for the S&P 500, while the 100 biggest Nasdaq companies trade 64 per cent above the S&P 500 relative to sales and 149 per cent relative to estimated revenue. Blackrock strategist Russ Koesterich notes the average biotech stock trades on a price/book ratio of more than seven, while "only the most creative metrics" can justify certain internet stock prices.

The go-go stocks may well race back to new highs, who knows? A good thrashing was well overdue, however.


Little evidence selling will spread
Some see the Nasdaq bleeding as a precursor to a broad market correction. For now, however, it looks more like a rotation out of overheated growth stocks and into better-valued sectors.

Even at last week’s low, the S&P 500 was barely 3 per cent off its all-time high. Typically, the Nasdaq volatility gauge is around 5 per cent higher than the S&P 500’s, but that has jumped to 35 per cent – the highest premium since 2007, indicating concerns remain confined to certain sectors.

The large-cap Dow Jones Industrial Average as well as major European indices were similarly subdued.

Tellingly, emerging markets, where value is most obviously present, saw equity inflows for the first time in 22 weeks.

Nor is there a rotation out of cyclical names – the Morgan Stanley Cyclical Index continues to look healthy.

It’s not even a full-blown rotation out of technology stocks – companies such as Microsoft and Cisco sporting low valuation multiples and decent dividends continue to do nicely.

So far, the market action looks like a move away from
last year's big winners –
internet, social media and biotech names – and into areas of relative value, a trend likely to develop as the global bull market matures.

Decoding the location signal
Here's a new method for predicting lousy earnings – watch out for where the annual shareholder meeting will be held.

A new paper, Evasive Shareholder Meetings, found a “systematic” pattern of poor company performance following meetings held a great distance away from headquarters. In cases where meetings were held at least 150 miles from headquarters on only one occasion over a five-year cycle, stock returns subsequently lagged by 11.7 per cent over the next six months.

The reason for choosing remote locations seems obvious – to “discourage scrutiny by shareholders, activists, and the media”. Shareholders don’t appear to “decode this signal”, however, as there is little immediate stock price reaction when the meeting location is disclosed.

Incidentally, the idea was sparked by a meeting with a European shareholder activist who said he could "reliably" forecast poor future share price performance when managers behave evasively – answering questions incompletely, cutting short shareholder speaking opportunities, excluding items from the agenda – during shareholder meetings. Add remote meeting locations to that list.

End of an era for Warren Buffett?
Has Warren Buffett lost his touch? Statistician Salil Mehta thinks so, given that Berkshire Hathaway, Buffett's investment vehicle, has underperformed over the last five years.

Buffett recently said he expects to underperform when the market is strong. Berkshire has underperformed in 10 of its 49 years, “with all but one of our shortfalls occurring when the S&P gain exceeded 15 per cent”.

However, Mehta views this as misleading on many grounds.

One, such strong gains are common, occurring in 24 of the last 49 years. Two, Buffett has underperformed in four of the last five years, compared to just six out of the previous 44 years. Thirdly, Buffett did just fine during previous bull markets.

During the five strong market years from 1995 through 1999, Buffett underperformed on just one occasion. There were three very strong years between 1984 and 1988, but Buffett outperformed each time.

Mehta isn’t taking a pop at Buffett, lauding his “incredible” long-term record of outperformance.

However, he calculates there is only a 3 per cent chance that the last few years of underperformance are a product of bad luck. That is, the superstar days are likely over.