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  • Nov 24, 2022 - What You Can Learn from the Great Crash in Tech Stocks

What You Can Learn from the Great Crash in Tech Stocks

Nov 24, 2022

What You Can Learn from the Great Crash in Tech Stocks

Tech stocks were the top choice for investors in 2020 and 2021.

Due to the work from home trend, major tech companies enjoyed a spike in revenues. For a while it seemed the world was on the cusp of a new digital revolution.

Tech stocks soared to new heights. The wealth of the owners of firms like Alphabet, Meta, Amazon, and many others, went into the stratosphere.

The market value of tech stocks dominated the total market value in most stock exchanges in the world. These stocks became part of the core portfolios of almost every investment fund.

As more investors bought them, their prices soared even higher, which brought in even more investors hoping to get a piece of the profits. This led to an almost self-fulfilling upward spiral. In the second half of 2022, it seemed only the sky was the limit for these stocks.

But, as they say, all good things must come to an end.

The Great Tech Crash

2022 will go down in history as one of the worst years for tech stocks, not only in the US and the developed world but also in emerging markets like India.

In the Indian stock market, all the Indian tech giants fell 52-week lows. Not a single tech stock was spared. The new age tech stocks have been taken to the cleaners.

The top tech IPOs have become the biggest wealth destroyers with more than Rs 3.5 trillion (tn) down the drain.

Value Destruction in New Age Tech IPOs

Tech Companies Issue Price Listing Price All time High All time Low Current Price Fall from the top
Zomato 76 126 169 41 69 -59%
Paytm 2,150 1,560 1,961 511 613 -69%
Policy Bazaar 980 1,332 1,470 367 387 -74%
Car Trade 1,618 1,501 1,501 460 505 -66%
Source: Equitymaster

The carnage in US tech stocks was enormous. the NASDAQ Composite Index fell 36% in less than a year from November 2021 to October 2022.

Individual stocks fell much more. Just look at the wealth destruction in the biggest US tech stocks from their 2021 all-time highs to their recent lows.

  • Meta -77%
  • Amazon -53%
  • Alphabet -44%
  • Netflix -76%
  • Apple -31%
  • PayPal -77%
  • Etsy -77%
  • Moderna -74%
  • DocuSign -87%
  • Tesla -59%
  • NVIDIA -66%

There are many more. The crash has affected every tech stock in the US.

Imaging losing 75% from the peak in Moderna, the company that developed one of the main covid vaccines, used all over the world.

Such has been the relentless selling in these stocks.

Reasons for the Crash

Tech stocks were the leaders of the global stock market rally since March 2020. In just 20 months, the NASDAQ Composite soared from 7,000 to 16,000. Major tech stocks delivered multibagger returns over 2020-21.

But the situation completely changed in 2022. Tech stocks have been the leaders of the market decline.

In the latest earnings calls, the management of these firms have warned of declines in revenues and profits. This only adds to the concerns about a slowdown in their growth that is already underway.

Also, the latest investments made by these firms in futuristic areas like AI, metaverse and the like are still unproven. Revenues and profits could take years to scale up to a significant level.

Then there are other issues like the business disruptions caused by the Russia-Ukraine war and the global semiconductor shortage which is likely to extend well into 2023.

The latest concerns of investors include soaring inflation, which has led to people cutting back on spending. Declining consumer spending is a huge negative for the entire tech sector.

But the biggest reason for the crash has been...

Rising Interest Rates

Tech stocks are growth stocks. Investors buy them expecting higher profits, and thus higher stock prices, in the future.

They are not valued on the basis of their dividends. In fact, many tech stocks don't pay a dividend.

Thus, when growth slows down, these stocks take a hit.

But they also take a hit when interest rates go up.

This is because interest rates are the driving force behind a stock's valuation. Investors are willing to pay more for future profits if the current interest rate is low.

In other words if they're getting low returns on risk free bonds, then they're willing to take higher risks by investing in growth stocks.

During the boom in tech stocks, US interest rates were low. This was the fuel for the fire.

When the US Fed started raising interest rates to bring down high inflation, the momentum in tech stocks disappeared.

And now there is yet another reason to be cautious about tch stocks.

Global Recession?

It's safe to say this is the most talked about topic in the financial world. You see, there is a legitimate fear of a global recession in financial markets.

Economists are of the opinion that a recession could occur in 2023. This is more likely if the US Fed's interest rate hikes stifle demand too much from individuals and businesses.

In fact some market gurus believe the US and Europe are already in a recession...and the rest of the world will follow.

This is extremely bearish news for tech stocks which have already fallen into a deep bear market. It's no wonder investors don't want to touch these stocks.

Now it's unlikely that the Indian economy will face a recession. India is growing fast and long-term investing is likely to produce excellent results.

However, investors are well aware that India won't be immune to a global recession. And that concern has tempered the bullish sentiment to an extent.

What About the Long Term?

If the short-term sentiment in the market is not supportive for tech stocks, is there good news on the long term front?

The answer is yes.

Everyone can see the growth of India's tech startups.

Don't limit yourself to the IT sector as a long-term investor. Today, the tech sector in India is dominated by IT services firms. But in the long term, India's tech sector will look very different.

The big IT services firms will likely still be around but the growing number of new age companies will dominate.

These companies are just startups today. As you read this, promoters of these startups are still worried about raising funds in a rising interest rate scenario and getting big investors to suport their vision.

But some of them will make it past the initial growth stage. And a few of them will inevitably become world leaders in their niche.

Long-term investors in these companies will become very wealthy indeed.

So what can we learn from this debacle?

Well, let's see how it impacts you as an investor...

  • What goes up must come down

    2022 will be remembered as the year investors woke up to the fact that markets don't go up in a straight line.

    If an asset has risen far is excess of its fundamentals, then the likelihood of a crash is high. The only question is the timing of the correction.

    2020 and 2021 were historic years for tech stocks. The tech rally brought back memories of the tech boom of the 1990s. But there was a difference this time.

    You see, back in the 1990s technology as a sector was not a huge part of the benchmark indices in the US. This time around they were the backbone of the market. Not only were the stocks large in terms of marketcap, but they were also outperforming.

    This meant that most ordinary investors had already jumped onboard this rally and were profiting from it. They were hit hard when the momentum in these stocks reversed.

    This brings us to the next lesson.

  • Size is no guarantee of safety

    It's natural for investors to think of large bluechip stocks as safe haven investments. But when these stocks are also delivering great returns, the temptation can be overwhelming.

    Why bother doing any research or due diligence when the companies are dominant in their market and well-understood by analysts?

    Retail investors thought they could not go wrong as they were buying large stable tech companies which were changing the world.

    That is not a smart way to invest. Profits for an investor is not assured in a largecap even if it's widely held and is a favourite of the market. Just look at Amazon and Tesla.

  • The hottest stock may not be the best stock

    A big reason for the huge rise in tech stocks was that they had a good story to tell.

    They wanted everyone to believe they were changing the world. Thus, the potential growth in revenues was unlimited.

    It was a good story and it helped to drive their share prices higher.

    But the problem with story driven stocks is that if the story changes, the stocks crash. Even worse, the company's story doesn't need to change for the stock to crash. A change in the market sentiment is enough.

    Just look at Amazon. Its business hasn't changed in 2022. The story is unchanged. But the stock has crashed because the market sentiment has changed. And when that happens the stocks that went up the most are the ones that fall the most.

    So in the long-term, the hottest stocks may not be the best...even if the business lives up to expectations. This is an important lesson to remember.

  • Interest rates matter

    The risk-free interest rate is like the force of gravity in the stock market. The higher it goes, the harder it is for stock prices to go up.

    And the most important interest rate of all is the yield on the 10-year US government bond. It has been rising steadily since last year. It was only a matter of time before the smart money turned cautious.

    This is also the reason why foreign investors have been selling Indian stocks since mid-2021. They knew interest rates were going to up due to high inflation and that would mean lower stock prices.

    And the stocks that would be hit hardest would be the ones trading at high valuations. In this case, tech stocks.

    Keep these lessons in mind. Investors who learn these lessons will have an edge over those who don't.

Happy investing!

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Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such. Learn more about our recommendation services here...

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