After the big tech companies’ meteoric rise on the stock market, valuations may be settling down again.
At least, that’s the concern of Truist chief strategist and CIO Keith Lerner. In a note last Friday, Lerner downgraded his firm’s rating on the tech sector to neutral from overweight, as companies like Nvidia, Apple and Google continue to lead the sector to its most extreme outperformance in decades.
Valuations of big tech companies rise
The stock market is incredibly narrow, with just a few mega-cap tech stocks driving the market rally.
Overall, the technology sector is up about 40% since November 2023, about 16 percentage points higher than the S&P 500 over the same period. The sector has outperformed the S&P 500 by about 11% over the past month, its highest level since 2002.
Truist
Valuations of tech stocks have become overheated in the short term, fueled by investor optimism, says Lerner: The sector’s forward price-to-earnings multiple has jumped from 26 to 31, up 19%, since May 1 of this year. These lofty valuations appear to be outpacing earnings growth, making now not an ideal time for investors to buy.
As you can see from the chart below, tech stocks are behaving similarly to how they did last year, and if they continue on the same trajectory, they may see a dip in the coming months before rebounding again.
Truist
Neutral, not underweight
But investors needn’t worry about a tech bubble: Today’s 44% outperformance seems modest compared to the 253% that tech stocks outperformed the S&P 500 at the height of the dot-com bubble.
Truist
Despite the downgrade, Lerner emphasized that Truist remains bullish on technology in the long term, and he believes AI will be a permanent driver of growth in the sector in the future.
Lerner is optimistic that new opportunities will arise to invest in technology beyond “The Magnificent Seven.”
“Better opportunities to deploy capital meaningfully will likely emerge and we will continue to explore better entry points to upgrade this sector in the future,” Lerner wrote in the note.
Where should you invest in the current market?
After downgrading tech stocks, Truist has shifted its focus to finding value beneath the market’s surface. Lerner is bullish. Communication Services and utility.
Both of these sectors are indirectly benefiting from the AI boom: Telecommunications companies are benefiting from government efforts to invest in the 5G network infrastructure needed to train AI models, while utilities are benefiting from a surge in demand as data centers consume large amounts of electricity.
Investors can gain exposure to these sectors through funds such as the SPDR S&P Telecom ETF (XTL), iShares US Telecommunications ETF (IYZ), Utilities Select Sector SPDR Fund (XLU) and Vanguard Utilities Index Fund ETF (VPU).
