Cybersecurity was supposed to be a resilient area of tech, but these ETFs are struggling

Published Sun, Jan 22 20237:06 AM EST

Jesse Pound @/in/jesse-pound @jesserpound

Tech stocks have had a strong start to the year despite slowing growth and layoffs hitting the sector, but one sub group within the sector that was supposed to be relatively sheltered from such macroeconomic concerns finds itself stuck in neutral instead. Through the first three weeks of the year, the exchange traded funds tracking cybersecurity stocks are underperforming the rest of tech sector. The iShares Cybersecurity and Tech ETF (IHAK) , for example, has returned just 1% in January, well behind the tech and communication services funds that are also sponsored by BlackRock. IHAK outperformed those funds in 2022, but still dropped nearly 26%. The January underperformance comes at a time when high growth cybersecurity stocks were expected stay in favor. The idea among many Wall Street pros was that security spending was virtually immune to budget cutting, even as companies tightened their belts ahead of a potential recession. Jon Maier, the chief investment officer at Global X ETFs, said that a rising number of instances of cyber attacks, geopolitical tensions and the continued shift of work to the cloud should help cybersecurity companies continue to grow, even in an economic slowdown. "From my perspective, it should be doing better in terms of performance because of the tailwinds that are behind cybersecurity," Maier said. Other Wall Street firms are also bullish. In a Jan. 6 note, Citigroup strategist Scott Chronert named cyber security a high conviction theme in the firm's model ETF portfolio. BMO Capital Markets analyst Keith Bachman expressed confidence in the industry in a Jan. 18 note initiating research coverage of Crowdstrike with an outperform rating. "We continue to believe that CY23 security budgets will be more resilient than other parts of IT, though not immune from a weak macro," Bachman wrote. But even a relatively mild slowdown in growth is still a slowdown, however unfamiliar, and that realization could suddenly be weighing on the sector. "Recent earnings misses and guidance reductions across cybersecurity vendors prove that the industry may not be as resilient to worsening macroeconomic conditions as initially believed," Bank of America analyst Tal Liani said in a Jan. 12 note to clients. "While we remain positive on the fundamentals of the sector, we also highlight a few risk factors: 1) overly bullish management teams, 2) high expectations and risks to estimates, 3) and further decline in relevant spending (such as enterprise) that is not yet incorporated into expectations." There could also be some technical trading reasons for the underperformance. Strategas Research strategist Chris Verrone flagged Palo Alto Networks and Fortinet as two stocks with worrisome charts in a note to clients on Thursday. But it's not as if cybersecurity threats are going away. T-Mobile announced on Thursday that it's investigating a data breach potentially affecting more than 30 million customers . Liani said that the current weakness in the stocks would likely prove temporary. "We expect the segment to pass the peak of spending adjustment by 1H and the stocks to start reacting positively to the solid underlying fundamentals in 2H," Liani said in the BofA note. On Friday, the industry got some positive news when Morgan Stanley analyst Hamza Fodderwala reiterated the bank's call on Palo Alto Networks, calling it a top pick and "an exceptional opportunity." Cyber stocks moved broadly higher, with the Global X Cybersecurity ETF (BUG) gaining almost 3%. If the solid end to the week proves to be the start of a trend, investors who stayed the course through a rough patch could still see long-term rewards. "Perhaps investors are just looking in other areas because it has been overkill on the cyber story, but … the adoption of endpoint cyber protection has to occur. The tailwinds are there, and topline growth is there," Maier said. — CNBC's Michael Bloom contributed to this report.