By: Steve Sosnick, Chief Strategist at Interactive Brokers

It is pretty much impossible to ignore the debacle that is Netflix (NFLX) this morning. It’s not every day that a popular growth stock loses a third of its value overnight – even if that same stock lost a fifth of its value the last time it released earnings. While there is no shortage of elements that are specific to NFLX, I see it as part of a broader theme that has been in place for several months – investors are punishing growth stocks that are no longer meeting their lofty expectations for growth.

In early February we posed the following question: “What happens when a leading growth stock stops growing?” The answer, as shown first by NFLX in January, then by Meta Platforms (FB), Chewy (CHWY), and various other market darlings, was to expect traders to slice about 20-25% from the stock price immediately after a disappointing earnings release. In a recent CNBC appearance ahead of earnings season, we flagged flagging earnings growth among investors’ favorite stocks as a key risk to watch in the weeks ahead. 

Yet we failed to fully address the possibility that some of the growth stocks would actually see shrinkage in their seemingly unassailable business models. Peleton (PTON) offered evidence of that situation, but its Covid-fueled ascent and subsequent decline were too easily dismissed as idiosyncratic. Sure, NFLX was also a stay-at-home stock, but people were Netflix-ing and chilling years before they’d ever heard of PTON. NFLX had a pedigree – it was the “N” in FAANG. But here is how investors punish growth stocks that don’t grow, with falls of two-thirds or more:

One Year Daily Chart, NFLX (red/green, right scale), PTON (blue, left scale)

(Click on image to enlarge)

Source: Interactive Brokers

In hindsight, it was folly to view NFLX as unassailable. While stranglehold on cell phone operating systems by (AAPL) and Alphabet (GOOG, GOOGL) offer them business models that would make an oligopolist proud, and the penetration that Microsoft (MSFT) and AAPL have on personal computer operating systems are similarly enviable, they were already in competition with AAPL and Amazon (AMZN) in that arena.There is now a myriad of well-funded competitors in streaming video, which include Disney (DIS), Paramount (PARA), Warner Brothers Discover (WBD) and more. NFLX had a distinct first-mover advantage in the streaming video space, but now they are forced to duke it out with competitors that have bigger catalogs of intellectual property, deeper pockets, or both.

All the aforementioned competitors are lower this morning as well, though none to the degree that NFLX is. One takeaway from NFLX is that strapped consumers may be cutting back on streaming video as inflation in true staples eats away at their purchasing power. If higher energy prices are eating into your family’s budget, streaming video might be a casualty. 

Now we need to see how a precarious stock like FB is greeted after it reports. Their vulnerability comes more from user fatigue and the government rather than immediate competitive pressures, so the risk may not be as acute. On the other hand, it is entirely possible that the other leading megacap tech stocks may find it difficult to meet investor expectations if they are viewed as bulletproof. Last quarter, investors rewarded solid results from AAPL, AMZN, GOOG, and MSFT. If they miss, their size makes them market risks, not stock-specific risks. As we wrote at the beginning of this year, just after the S&P 500 reached its all-time high:

After March of 2020, the tech sector was perceived as a relative bastion of stability, pushing VIX sharply higher relative to VXN. If investors had a change of mindset that changed their fundament perception of the relatively crowded tech sector, the rush to exits from a crowded trade could have a profound effect on tech volatility specifically and market volatility over all.

Investors need to hope that their favorite growth stocks keep growing.