Tech valuations have become attractive again: UBS

The recent sell-off in tech stocks led to a retreat in US equities last week, with the Nasdaq’s 2.1% loss outpacing the S&P 500’s 0.8% decline.

As a result, the outperformers of the first half of the year have become underperformers this month, as investors rotate out of big tech into laggards. Since the start of July, the Nasdaq has fallen 2.1%, while the Russell 2000 small-cap index has risen 10.4%.

According to UBS strategists, this reversal is in part driven by mixed interpretations of earnings reports from several prominent tech companies over the past week. Following an impressive run since late last year, investors are increasingly concerned about the pace and timing of artificial intelligence (AI) revenue and its implications for continued investments in AI infrastructure.

“With results still due from some big firms this week, market volatility is likely to continue,” the Global Wealth Management Chief Investment Officer at UBS said in a note.

“But we think the tech sector should find support in the coming weeks and resume its leadership. In fact, the recent pullback creates a re-entry opportunity, in our view, especially for those companies with strong earnings growth visibility.”

Over the past decade, there has been at least one 10% valuation reset in global tech every year, except for the strong bull market in 2017.

Excluding the 30% reset in 2022 driven by rising interest rates, UBS notes that tech indexes typically rebound strongly in the six months following a 10% correction. With key global tech benchmarks having declined 9-10% from their recent peaks, analysts at UBS believe this provides investors with tactical opportunities.

Moreover, while the tech sector appears expensive after this year’s rally, price-to-earnings (P/E) multiples remain “much lower than the dot-com era, when many tech stocks had much lower quality earnings.”

The fundamentals within the technology sector remain solid, while the technical factors supporting the rotation from large caps “are likely to fade.”

“We think the environment remains favorable for quality tech stocks, and believe that investors should ensure they have sufficient exposure to AI beneficiaries within and outside the US,” the Chief Investment Officer added.