Is the tech correction here to stay?

Despite a tricky 2022 so far, TDAM analyst says diversified exposure to the space remains a good strategy

Is the tech correction here to stay?

This article was produced in partnership with TD Asset Management.

Compared to recent history, 2022 has been a rough year so far for the broad stock market: one week into March, energy was the only sector to show positive year-to-date performance. And near the bottom of the standings sits the biggest winner during the height of the pandemic crisis, and one of the stock market’s best performers historically.

“The tech sector is the third-worst performing sector for this year so far,” said Trevor Cummings, Vice President of Exchange-Traded Fund (ETF) Distribution at TD Asset Management Inc. (TDAM), in a recent interview. “But if you look at the data going back over a quarter century, it’s also been one of the three best-performing sectors. So the million-dollar question is: is this a permanent changing of the guard, or an investment opportunity?”

To help investors get low-cost exposure to the tech sector, TDAM offers the TD Global Technology Leaders Index ETF (TEC). TEC was pioneered with the intent to offer a pure technology solution that seemed to be lacking in the current marketplace. TEC seeks to track the Solactive Global Technology Leaders Index (CA NTR), a custom index designed in conjunction with TDAM that tracks the performance of global mid-and-large capitalization issuers, including tech giants such as Apple, Meta, Amazon, Tesla, NVIDIA and more. 

Technology was already showing above-market returns even before the pandemic, but the arrival of Covid-19 in 2020 supercharged its outperformance. As the physical economy was practically shut down, digital businesses saw their earnings skyrocket; by the end of that year, TEC had outperformed the S&P 500 by about 20%.

“By 2021, investors got a little too complacent,” said Vitali Mossounov, Global Technology Analyst at TDAM. “A lot of people started believing that Covid and low interest rates will be with us forever, which drove more share price performance in the second half of 2021.”

Then the tables turned. After a multi-month streak of decades-high inflation, investors started to seriously consider the likelihood of higher rates, and how it could weigh on the future earnings of high-growth sectors like tech. After peaking in November, the sector’s outperformance started to slip.

It wasn’t until the end of January that tech firms could report their earnings outlooks and ease shareholders’ fears. While PayPal and Meta, nee Facebook, scared investors with their poor outlooks, Mossounov says the two were outliers. Overall, companies in the broader tech space reported strong fundamentals through their earnings and outlooks for the year.

“What’s unfortunate today is that the focus has shifted,” Mossounov added. “Given the macro environment and Russia’s invasion of Ukraine, people are beginning to fear everything, and there’s indiscriminate selling in a lot of areas of tech.”

Indeed, the market today is seeing extreme volatility. The past few months have also brought wider dispersion of returns among tech companies; the gap between winners and non-winners has increased, which means investors who’ve been able to juice their portfolios with just a few tech names may want to change tack.

“You could take one of two paths,” Cummings said. “On one hand, you might want some active management in your portfolio to try and separate the good performers from the ones that aren’t performing well. On the other hand, you could diversify broadly across the space.”

Choosing winning tech names isn’t as simple as favouring high-quality companies over lower-quality ones. Cummings cited Alphabet, Google’s parent company; within three weeks of announcing blowout results, it had lost all those gains as its share price tumbled. And while keeping up with the businesses within an industry is a full-time job in itself, that challenge is significantly compounded in the technology space, where changing the game is literally the name of the game.

“You're not talking about static businesses, as you are in many of the other sectors,” Mossounov said. “When you're dealing with this high rate of change, the dispersion will be very high, and failures will happen.”

On the whole, Mossounov believes that technology companies are among the most well suited to weather periods of high inflation; aside from having few commodity inputs, they’re able to pass price increases on to customers because they have tremendous value propositions for services they’ve underpriced for a long time. But he also emphasizes that for the average investor, stock-picking is a risky proposition.

“For an investor trying to be a hero and just pick one stock, the probability of getting one with zero return is much too high,” he said. “It's just not a good strategy in light of what's available with some reasonable diversification.”