Tech Is In La-La Land

Technology has rallied strong in recent months and particularly the past few weeks with the Invesco QQQ ETF up now over 20% YTD even as broader indexes remain still down. Much of this rise is well-merited as technology was much better positioned to take the sudden COVID-19 business disruption than other industries due to the nature of its business model and the huge cash reserves many technology companies had on hand.

Yet I think the tech rally has reached some of its last legs for the moment because its valuations have soared far beyond what is justified based on current business and economic projections. Times are good for tech but it has gotten a bit ahead of itself, trading on hopes far further down the line and with a premium due to a lack of other safe sectors, and I believe soon enough its current rate of growth will slow and perhaps even reverse for a time.

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Data by YCharts

Much of Technology's Rebound Is Warranted

In mid-March, I stated repeatedly that technology was likely to outperform other sectors due to their more impact-insulated business models amid the pandemic and their huge cash reserves and since then this has proven true and remarkably so.

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Data by YCharts

Some technology companies like Netflix and Zoom are seeing increases, even if just temporarily, in core business due to developments such as increased work-from-home and general lockdown orders. Yet these tech companies, whether lockdown friendly or not, skyrocketed during the shutdowns and now during re-opening and which means clearly there was and is a greater buying push towards them besides the impact of the closures on their operations.

I believe the fundamental driver right now towards the technology sector is essentially finding safety in and paying a premium for, quality. Bankruptcy reorganizations are soaring at a horrifying pace as even companies whose businesses weren't totally shut down before or now still experiencing unbearable financial strain. This has made it extremely difficult to determine which companies are unlikely to go through equity-destroying bankruptcy reorganization or may face the long-lasting albatross of historically surging corporate debt. Investors, therefore, are searching for companies where they don't have to worry about potentially business-ending trauma and seem to have been and are willing to pay an elevated price-to-earnings multiple premium for that as compared to past years.

Tech seems like the only sector with an inkling of pre-coronavirus normalcy in that many tech companies were/are flush with cash and have seen perhaps some of their businesses disrupted due to coronavirus but not as dramatic as many other sectors and therefore are avoiding the existential risks still affecting nearly every other sector right now. The tech industry, like other companies, is likely to benefit in nominal terms from the seeming inflation increasingly creeping into the markets. Furthermore with the collapse of many brick-and-mortar businesses there actually may be an opportunity for some enterprising tech companies to expand their businesses in this void as the recent rumors of an Amazon acquisition of Macy's and/or J.C. Penny's seems to demonstrate.

Despite this, I recently in the past two added a moderate short position of QQQ to my portfolio at currently an average cost basis of $253.11.

Tech Isn't Weightless And Gravity Will Return

While Monday was not a pleasant day necessarily for that part of the portfolio as the Nasdaq and QQQ, soared amid this continued flight-to-quality and floating into nothingness I know that volatility is part of any trade and particularly in a sector as based on hopes and dreams, rather than weighed by cold hard earnings, as the tech sector is.

I remain bullish on technology in the long-run because I think many tech companies still remain well-poised to continue to survive and grow after weathering perhaps the worse of the COVID-19 spurred recession/depression. However in the short-run, I believe the Nasdaq, QQQ, and tech, in general, has gotten a bid ahead of itself.

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Data by YCharts

The above chart is one of QQQ in the later part of the dot-com bubble and its collapse. As you can see, gravity even came to these high-flying tech companies that weren't posting positive earnings and were barely functional. We saw even last week how Lemonade IPO'ed to 15x its annualized Q1 2020 revenue, not earnings, and is now at $82 a share from its $29 IPO price after just a few days. That there's talk of other tech companies wanting to IPO that are either too underdeveloped to really go public under normal circumstances and lack the mature business model to build the confidence of tech investors makes me concerned this market has gotten a bit too hot and that momentum is going to start to slow for a bit.

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Data by YCharts

Conclusion

It boggled many investors' minds that the Nasdaq easily raced past its previous all-time highs before the world had taken COVID-19 into account and markets crashed. It is increasingly converting even many of the final holdouts against rallying markets to bulls and meaning that potential buyers are now truly increasingly few. That is why in the short-run I think the Nasdaq, and QQQ as representative of the tech index, is very much due for a correction and I have such conviction in such that I've initiated a short position.