Why Tech Stocks Fell Hard In October

Last update on Nov. 5, 2018.

Image Credit: Mattz90 / Shutterstock.com

 

At the beginning of every month, I brief members on how MoneyGeek's Regular portfolios have performed and comment on the state of the financial markets. In this update, I’ll also comment on the fall the stock market took this October.

 

October Performance of Regular Portfolios

The performance of MoneyGeek's Regular portfolios for the month of October 2018 were as follows:

 

Last Month

Last 12 Months

Since Apr 2013

Aggressive

-5.8%

-0.7%

+89.4%

Growth

-5.1%

-0.6%

+74.3%

Balanced

-4.5%

-0.6%

+59.9%

Conservative

-3.9%

-0.7%

+46.4%

Very Conservative

-3.2%

-0.6%

+33.9%

 

I've chosen to list below the performance of some of our competitors. For the sake of brevity, I've decided to show only those portfolios that have a similar risk profile to MoneyGeek's Regular Aggressive portfolio.

 

 

Last Month

Last 12 Months

Since Apr 2013

RBC Select Aggressive Growth

-6.2%

-3.4%

+33.3%

TD Comfort Aggressive Growth

-6.1%

+6.4%

+20.0%

CIBC Managed Aggressive Growth

-6.2%

-7.3%

+7.7%

Canadian Couch Potato Aggressive

-5.6%

-1.5%

N/A

 

In contrast with our competitors, MoneyGeek’s Regular portfolios employ stocks/ETFs that follow the value investing strategy (QVAL, IVAL and BRK-B), and also allocate a larger percentage of the portfolios toward Canadian oil and gas stocks (XEG.TO) and gold (CGL-C.TO). If you would like to take a look at our portfolios, I invite you to sign up for our free membership.

In October, Regular portfolios performed in line with their competitors. While CGL-C.TO went up, offsetting the effects of some of the stock market declines, XEG.TO plunged hard because of falling oil prices. To put the current valuation of XEG.TO into perspective, the ETF’s price is now back to where it was in Feb 2016, when oil prices in the US were less than $35/barrel (it’s $63/bbl as of the time of this writing). I won’t elaborate any further on oil stocks since I do enough of that in my other articles.

The stock market in general hit a rather rough patch in October. The S&P 500, which tracks the 500 biggest companies in the US, declined by 6.8% in US dollar terms. Interestingly, the stocks that led the declines were the same tech stocks that had been flying high these past few years. Amazon and Netflix, for instance, went down by 21% and 20% respectively during the month.

The catalysts for the tech stocks’ downfall were disappointing earnings reports. Many companies, including Amazon and Google, reported lower revenues than analysts had expected. This stoked fears that the period of rapid and predictable growth was ending for these tech giants.

As I’ve explained before with Facebook, growth is everything for investors of these stocks. Financial analysts often look at a variety of financial ratios (e.g. P/E, EBIT/EV) to determine whether a company is cheap or not, and most of these ratios indicate that tech stocks are expensive. Now, tech stocks can justify their expensive valuation if they can continue to grow rapidly. But if growth goes away, their valuation is no longer justified and stock prices tend to come down.

As the prices of these tech stocks have fallen, some might wonder if this presents an opportunity to buy. I would urge caution for the simple reason that the valuations of these companies are still very high.

To justify even the lower prices seen today, companies like Amazon and Netflix would have to grow revenues at double digit rates for many years to come. But given the massive size these companies now are, continued rapid growth will become increasingly difficult as it gets harder to fight bureaucracy and find new markets of sufficient size.

History offers us cautionary examples with respect to the growth of large companies. In the 60s, there was a group of fast growing large stocks called the Nifty Fifty, which because of their consistent growth commanded expensive valuations. But as their growth slowed along with the economy in the 70s, these stocks crashed badly, giving us another reminder that valuation matters.

Although we can never be certain that the tech stocks of today will suffer the same fate as the Nifty Fifty, I believe there’s a good chance they will. I will thus stick to the tried and true value investing principles with regards to the composition of the Regular portfolios.

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