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  • Writer's pictureGVA Research

5G and cybersecurity stocks will be winners amid tech rebound: David Garrity on BNN Bloomberg

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The rebound in tech – what’s behind it?

The recent period of stock market consolidation (i.e. the S&P500 is up only +0.9% to date in June against a +12.9% year to date advance) represents a market that is growing into its optimistic valuations. As such, investors should expect more moderate returns and more market volatility ahead. This is the most likely case as while the elements supporting the containment of COVID and the re-opening of the global economy continue to remain in place, the outlook going forward has become more mixed based on the following considerations: 1) Monetary support from The Fed has become more qualified following last week’s FOMC meeting, something of which investors should be mindful was always a question of when, not if; 2) On the fiscal front, Congress has not strayed from its partisan ways with governing becoming more a matter of obstruction than compromise, a development not supportive of prospects for further fiscal stimulus, something on which investors have very much relied since the March 2020 lows; and 3) The pace of vaccination in the U.S. is encountering challenges in meeting the Biden Administration’s goal of 70% by July 4th as states away from the East and West Coasts have not seen the necessary uptake, all this while the more infectious Delta COVID variant is becoming increasingly, and troublingly, prevalent. As indicated the outlook has become more mixed on a number of fronts. That said, earnings estimates for 2021 and 2022 continue to move higher, but remain at a level that should allow for solid outperformance in the upcoming 2Q 2021 and 3Q 2021 earnings periods. Nevertheless, the market has been overcome by a “growth scare” as seen in 10-year Treasury yields declining and the Russell 1000 Value ETF selling off -2.4% (year-to-date +15.0%) since the end of May as the Russell 1000 Growth ETF has gained +4.4% (year-to-date +10.8%) with investors increasingly concerned that the point of “peak reflation” is past.

A quick look below at S&P earnings expectations for 2021 and 2022 by sector shows that the Tech sector will be among the five sectors in 2022 growing earnings faster than the S&P 500 index (see sectors highlighted in yellow), an important consideration now as the stock market tends in the June timeframe to start looking ahead to next year's earnings performance in allocating investment capital.

Note also that the Tech sector is showing the highest annual earnings growth rate from the last peak in S&P 500 earnings in 2019 to 2022, a level of 18% which is matched only by the Materials sector.

In valuation terms, the Tech sector's valuation at 27x the 2021 EPS forecast compared with the 18% earnings growth rate delivers a price-to-earnings growth ratio of 1.5x, an attractive discount to the S&P 500's 2.2x. Note that as the Tech sector tends to create its own growth by disrupting industry incumbents as its constituent companies enter new markets the growth prospects for the sector are perhaps less dependent on the pace of economic recovery than other high 2022 earnings growth sectors such as Industrials, Energy and Consumer Discretionary.

Bottom line, the current "growth scare" highlights the attraction of the Tech sector given its more likely profit growth performance and valuation relative to its growth prospects being at a discount to the broader S&P 500 index. In this way, Tech is a means to establish portfolio exposure to growth at a reasonable price.

The rebound in tech - how long will it last, what are the risks and what kind of tech stocks will do the best? The rebound in tech is likely to persist to the extent that economic data come in below forecast, a development that will likely serve to prompt further profit-taking in the more economically sensitive sectors that have led the market advance during H1 2021. The fact that COVID vaccination rates have slowed, that some vaccines (e.g. SinoVac) have proven to be ineffective against re-infection, and that more virulent COVID variants have had the opportunity to develop in this setting raises the concern that global economic re-opening may prove to be more gradual than presently forecast by the IMF and others. For Tech, bad economic news is good news for investment performance as investors look for a relatively safer place to allocate capital.

On the flip side, economic data exceeding forecasts will prompt further market leadership from cyclical sectors such as Consumer Discretionary, Energy, Industrials & Materials,

Tech names that are well-positioned are those set to participate in the roll-out of 5G wireless communications (e.g. ADI, ATEX, DISH, ERIC, NOK, NXPI, QCOM), a growth driver set to accelerate well through 2022. Also, the continued rise in ransomware attacks with expanding economic impact is highlighting the need for further improvements in companies involved in cybersecurity (e.g. AKAM, CSCO, CVLT, FTNT, NET, NLOK, PFPT) as it is highly unlikely the virtual world will become safer on its own anytime soon.

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