Market re-rating of tech sector will bring volatility

A feature of the stock market for much of this year has been the search for a new valuation level for those parts of the tech sector whose fortunes have been transformed by the coronavirus crisis. But in the dog days of August, things really got out of hand.

Re-ratings like this, when they take hold, are often accompanied by significant volatility. That became clear on Thursday, after a wobble that saw Apple lose 8 per cent, or more than $150bn, of value.

Finding a new level is imprecise and subject to significant overshoot — particularly in the kind of extreme financial conditions that have prevailed in recent months.

The stock market’s feedback loops have magnified the effects. Retail investors have piled into the market, adding to the summer’s momentum-driven tech rally. Heavy derivatives trading — particularly in the form of unusually large purchases of call options — may have added a technical twist. Stock splits had an explosive effect on Apple and Tesla, setting a fire under both stocks and helping to pull the entire sector up.

But the trigger for all of this has been a reassessment of the fundamental outlook for large parts of the tech sector. Besides its short-term effects, the coronavirus crisis has, by popular agreement, given a longer-term lift to the digital economy. Those companies for which demand has held up — or increased — in this year’s economic crisis have come out the winners.

Most notable has been Tesla, whose shares jumped 81 per cent after it announced a stock split on August 11 — an event with no effect on the intrinsic value of the company — before dipping back. Tesla has been unusual in enjoying strong demand in a weak car market, fuelling hopes that it, alone, is well positioned for the electric vehicle revolution it did so much to launch.

Tesla is an extreme example, but sharp reassessments have been a characteristic of peak summer trading. Take the ascent of Nvidia: After overtaking Intel to become the world’s most valuable chipmaker in July, its shares rose another 40 per cent. Wall Street is betting that the processing demands of artificial intelligence will bring a fundamental shift in the demand for silicon.

The enterprise software sector — which has already seen probably the biggest re-rating this year — is still open to some startling stock price adjustments. Salesforce climbed 26 per cent on a single day last week after it revealed that customers were still spending heavily on complex digital transformation projects, despite the difficulties of maintaining even normal operations during the pandemic.

This week it was the turn of video conferencing app Zoom. Already a runaway winner from the pandemic, Zoom’s shares soared 41 per when it revealed its base of large customers had ballooned nearly fivefold, to 370,000. In effect, Zoom has gone from promising start-up to established enterprise technology power in the space of half a year.

Moves like these translate quickly into big shifts in relative value. Salesforce only surpassed arch-rival Oracle in stock market value earlier this year, but is now worth 40 per cent more. Zoom, an internet communications company with ambitions that reach far beyond video, is worth more than half as much as AT&T. Nvidia’s market cap is now 60 per cent higher than that of Intel, a company whose free cash flow last year was more than three times greater.

After its latest share price spike, Tesla alone represents a third of the $1.3tn capitalisation of the world’s 25 most valuable carmakers.

These comparisons are a reminder of how quickly the stock market adjusts when investors’ collective perceptions about the future shift. But product markets usually don’t tip as fast as valuation adjustments like this imply.

The August tech spike also extended one other notable re-rating. After reporting strong earnings and announcing its stock split at the end of July, Apple’s shares jumped 37 per cent, adding $600bn to its market capitalisation.

Two years ago, when the iPhone maker’s value first surpassed $1tn, Wall Street was debating what effect its move into services would have on its growth and margin profile. Its price/earnings ratio stood at 19.

Since passing $2tn this month, Apple’s market value has continued to levitate and the multiple now stands at 40. The market now seems to have decided that Apple is no longer what it was deemed to be for many years — a hardware company whose fortunes were tied to defined product cycles. Instead, it’s now a powerful tech platform, with multiple ways to extract high-margin revenue streams from a loyal global customer base.

It could well be that Wall Street is right about assessments like this. But, particularly at a time when financial conditions and market dynamics are so favourable, it is hard not to see excess in the re-ratings.