It’s been a rough start for tech stocks in 2022, with the Nasdaq falling 6% in the first week of trading. Decliners include both speculative and mega-cap names. Kim Parlee speaks with Vitali Mossounov, portfolio manager, TD Asset Management, about the year ahead for the tech sector.
Well, it's good to put things in context right away. I think that coming right after the new year, a bit of a sell off catches everyone off guard. It's highly unexpected, so there's a bit of a panic that sets in. The chart I've brought here simply shows the relationship between technology and the overall market, and we'll use the Nasdaq as a proxy of technology and the S&P 500 as a proxy for the rest of the market. When the chart is going up, that means technology is outperforming the market, and you can see the last five years is generally a consistent theme of technology doing better than the rest of the market. The last 18 months has been more of a tug of war. Sometimes tech does better, or sometimes it's the other sectors. And specifically thinking of the sell off that we have in the last few days, you can see that it's not particularly unusual. The magnitude is at 6% underperformance relative the market and 30 trading days. Actually, since the beginning of November, we had something very similar, a little bit worse actually, 9% underperformance over 60 days last year. So nothing really too crazy going on out there, Kim.
Can you give me a little more context? I think it's pretty well known that everyone thinks as we get concerns about bond yields rising, the opportunity to put your money elsewhere, it gets more attractive. Is that it? Is that the only thing with the story right now in terms of the tech sell off?
Well, we look at it two ways. One, when would get really concerned about technology as a sector? When with the underperformance be justified, warranted? And when will we be worried about more underperformance? That would be the case if there were something fundamental that was wrong. Some fears that we had on the horizon. As we sit here today in January and look at the next year of how these companies are going to fare, whether it's semiconductors, software, hardware services, we are seeing things as actually being pretty rosy out there. So in this case, of course, the market's focus is on those exogenous factors, as they say, its inflation, its rates, its reopening to some degree throughout 2022. And it is the relatively higher attractiveness of other sectors that's causing technology to be a source of funds. But again, that's not an unhealthy kind of underperformance.
Just to be clear, again, to your point, we're trying to dissect, if you will, the reaction. There's a financial reaction and then there's a fundamentals. You're saying the fundamentals look good. But just going back to the rates and the discount rates for future cash flows, they do look less attractive when rates do go up.
Sure. I'm not going to argue with that, that is finance theory and a mathematical proposition that's correct. But people have to be careful about what they're talking about when they're referring to that theory. Certainly, when the discount rate goes up, future cash flows are worth less and that's going to be the case, more so for companies that aren't making any money today, and their cash flows are in some distant future, 10 to 20 years away. And those companies do deserve to get knocked back harder when rates go up, or expectations for rates go up. That's what's happened. We're seeing some of these highly unprofitable companies, companies that are very speculative, get sold off quite a bit. But that's not at all what's happening or what should happen to the companies that are making money today, and some of the greatest franchises you can think of, Microsoft, Apple, Alphabet. These businesses are just as profitable and trade at roughly the same valuations as the other great non tech franchises, let's say Costco, Starbucks or Nike. So we really have to be careful. The majority of the tech market, this interest rate argument does not apply to it any more than it does to other sectors.
And despite that, to your point, if you take a look at the big players you mentioned, Microsoft, one of the biggest out there, not as big a sell off as the tiny tech players. It did sell off. It's come back a bit today, but a pretty steep decline last week.
Exactly. That, you could say, is a bit unfair, but again, that's the nature of the markets. They are not always rational and they're certainly not predictable and would you want to caution investors looking at Microsoft on a one-day or even one-week trend? It doesn't make much sense, frankly. This is a company with terrific fundamentals. It's giving investors an average of a 40% return in the last five years. And there is nothing really to to worry about at this juncture there.
I want to bring up a few charts here, and I've only got a couple of minutes Vitali, so we've got here the top 10 holdings of the TEC, T-E-C, Technology Leaders ETF, that TDAM has. We can see some of the big names here. And then we've got a second top 10 holdings chart we'll bring up shortly. But what is notable about these in terms of why they're there and, anyway, go ahead.
Well, TEC was important to pull up this chart we've got now, I think, the largest technology ETF in Canada, if I'm not mistaken. And when there is this sometimes panic in the market, investors can forget exactly the kind of high quality holdings that they have. And so the top 10 of TEC, those are household names. And again, not to repeat myself, but I will, some of the best franchises in the world. Period. That generally trade at reasonable valuations. And so it's not the spec tech stuff.
And if we bring up TECI, you've got another here, which takes a look at these top 10 holdings. And again, some of these I know are expected to be some of the emerging big players coming out in the next little while.
Yes, and we had the pleasure of launching this at the end of November. It's our second technology ETF. Now you can see these are not the big tech companies. Those are not eligible. The goal here was to say, look there a big tech in the market and TEC might be the right vehicle for you to do that. And then there's products out there that are capturing the very speculative side of the market companies that might be the next Tesla 10 years from now. But we wanted to capture what I would call the sweet spot of commercial innovation companies growing rapidly today, investing money, but getting returns on that money, and also growing their margins at the same time. So companies that already have a great product that everybody wants, and that's what you see is in this ETF.
I know you've also brought a chart where you're taking a look at some of the big pullbacks that we have seen in the Nasdaq, I think it's about since 2010, and this one's fascinating if we bring this one up. The Nasdaq, of course, is where all the growth has been, but it's also where all the volatility has been compared to some of the other big indices.
Yes, and this is another one of those charts to give investors context at a time when there may be a proclivity for panic. We've had 10 or so large, and large I define over 10% pullbacks, in the last decade. The base rate is each one of those has been a buying opportunity for the Nasdaq. And actually, we're down 9% or so as of a couple of days ago. So again, I don't know the near term, we could be down a few more percent. We could go up from here. But the bottom line is to keep things in context. These things do happen, but we need to focus on the fundamentals and the long term.
Vitali, it's hard to keep in mind the fundamentals when you take a look at your portfolio sometimes and you see the volatility because there's been some big big drops in stock prices right now. So how do you keep the long term picture in mind?
Well, investors, first of all, have to ask themselves if they do find themselves at a period like this in a sense of panic or break into a sweat once too often, then probably they should look to some professional money management or other solutions that can take that load and stress off of them so they can focus on what they do best. And second of all, it is to zoom out and look at the broader picture of the market. And for technology, what we're thinking about and speaking about today, the innovation that you're seeing around you, is that coming to an end? Will 1% higher interest rate change fundamentally what companies are invested in how the world might look in five to 10 years? Ask yourself those questions. And if you feel comfortable that the answer is no, then stay calm and keep calm and carry on as they say.
Vitali, always a pleasure. Thanks so much.