Tech Sector No Longer A Safe Haven

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Graphics chip maker Nvidia Corp. (Nasdaq:NVDA) has been enjoying a glorious run over the past six months. The stock is up about 40% since June, compared with an essentially zero return achieved by the tech-heavy Nasdaq Composite Index over the same period.

Tech stocks as a whole have been seen as a safe haven, while credit markets have been troubled by housing losses and the economy looks to weaken in the second half of the year. One of the prevailing theories was that business spending would prop up earnings over the next few quarters, even if consumer spending fell off.

Nvidia On The Move
When I highlighted Nvidia back in May, I noted that margins were hitting an impressive growth spurt (To read the full article, see NVIDIA Battles The Big Boys). This trend has continued into the fiscal third quarter. For the period ending October 28, Nvidia posted gross margins of 46.2%, up over 500 basis points from the same period last year. Net margins grew even faster, coming in at over 21% in the third quarter - this is up from only 13% a year ago.

All of this translates into third-quarter earnings shooting up over 120%, with revenue up a stark 36% from the prior year's third quarter. This kind of expansion from a company already planted in the S&P 500 means that its products have very strong core demand, and also that efficiencies are working their way through the manufacturing and supply chains.

The Great Tech Exodus
And yet through all of this, tech shares have been dropping for the past month. If a company can beat estimates and perform the way Nvidia has, and still sell off in the aftermath (the stock is down over 10% from its November high point), things don't look to be shaping up well for a good fourth quarter for tech stocks.  

Nvidia could be seen as emblematic of the tech sector as a whole - strong share performance through most of the third quarter, partly because of perceived strength in business spending, and partly as a safe haven. After all, tech is about as far away from housing and the related credit crunch as one can get, and that has held some appeal.

But concerns about the economy are now spreading from consumers to corporations. If credit markets continue to tighten, companies may have to hold off on some of their capital expenditure plans, which will dampen the prospects of any tech company that has a significant corporate sales segment. Nvidia is also highly exposed to the level of discretionary spending in the economy, which could cause pricing to weaken and therefore margins to compress.


Parting Thoughts
I am concerned about investing in tech with the "safe haven" approach. There just isn't any margin for error if a company misses estimates, or even if it exceeds expectations modestly. Because most of the multiples on tech stocks have risen steadily over the summer, P/E ratios are higher than what you'll find in other sectors. If recessionary concerns persist, I think investors will start forgetting about the areas that may have caused it (like housing and securitized debt products) and just start looking for relative value in the form of low valuations and stable cash flows.

For further reading, check out Sector Rotation: The Essentials.


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By Ryan Barnes

Ryan Barnes has over 10 years experience in portfolio management and investment research, covering equities, fixed income and derivative products. Barnes has worked with Merrill Lynch, Charles Schwab, Morgan Stanley and many others as an institutional trader, and maintained AIMR compliant performance for a diverse set of high-net-worth investors.

Barnes is currently working as a writer and financial modeling consultant specializing in capital appreciation and hedging strategies, and is the editor of EpiphanyInvesting, a website devoted to finding long-term success in the stock market.

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