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As summer tech rally fizzles, bears are on the prowl

Optimists see a sustained rally starting just before Christmas, the pessimists a slow grind through the winter.

Technology stocks were the star of the stock market show for most of two pandemic years, but since the new year, they have been in steady retreat.

Even after the summer rally, the Nasdaq Composite Index is down 21% year-to-date at the time of writing. Not even the heavyweights have been spared.

Shares of Google’s parent Alphabet (NDQ:GOOG) are off 21% year-to-date adjusted for its recent split. Stumbling Meta Platforms, (NDQ:FB) the renamed Facebook is down 52%. Shopify, Canada’s answer to Amazon, (NDQ:SHOP) has performed even more poorly and is down 76% post-split. Amazon, (NDQ:AMZN) post-split is off 20%.

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Investors may be wondering if the worst is over, or if there’s more to come as we start seeing  third quarter earnings. They get going in earnest this week with the big banks. Although there is plenty of opinion on both sides of the argument, the consensus seems to be there’s more selling pressure to come. Interest rates will rise further this fall – though likely at a slower rate and inflation will stay high, though perhaps has peaked. Consumer confidence remains weak.

The optimists see a sustained rally starting just before Christmas, the pessimists a slow grind through the winter.

Nobody can predict the future, though many claim they can. How long or deep this setback will be can only be known in hindsight, so here are some things to keep in mind as we muddle through the near term.

Quality always wins

Companies that sell things we need, rather than things we want, do well in all conditions. These are the products and services that are noticed if they go missing. Microsoft, Google and Amazon tick that box.

These companies have brand and pricing power and can pass on inflationary costs. They have experienced many expansions and recessions and have the resources to expand and acquire competitors at times like these. Microsoft’s US $67 billion takeover offer for Activision Blizzard Inc. (NDQ:ATVI) to bolster its Xbox gaming segment is an example. Amazon closed an $8.5 billion acquisition of  MGM Holdings in March which gives it Metro-Goldwyn-Mayer’s film library for its Prime streaming service.

These companies also have money for research and development to maintain their dominance. R&D is a hidden asset that leads to new products. Microsoft will spend US $24.5 billion this year on R&D, or 12% of revenues. Amazon will spend  $62.6 billion, 13% of revenues. IBM will spend $3.6 billion, or 6% of revenue.

Markets overreact both ways

Zoom Video Communications (NDQ:ZM) had a price earnings ratio (PE) of 1,790 ahead of its earnings two years ago in August, 2020. Its shares were trading at US $370.  

Between then and now revenue rose 558% to $4.1 billion in its latest trailing 12 months. Net income rose from $25 million to $1.3 billion.

Zoom is eminently more valuable and profitable today than two years ago, yet worth far less on paper. Its PE ratio has fallen to 21 and the $81 share price is 78%  lower. This sort of repricing offers opportunities.

Patience, patience, patience

Investing success relies on a tolerance for risk as conditions change, diversification by sector and geography and sticking to a plan. The economy goes up and down, as do share prices, but over the long run studies show investment in large cap US stocks has an average annual return of between 7% and 9%.

When things seem worst, the worst may be over

Sadiq Adatia, Chief Investment Officer at  BMO Global Asset Management in Toronto, said recently he sees the current market uptick as a bear rally because what’s missing is capitulation by small investors. When they throw in the towel and sentiment is at its worst, it usually signals a bottom. Thereafter,  irrational pessimism can quickly give way to irrational exuberance. 

Be realistic

Many of the pandemic highflyers are not going to regain their highs soon. Greg Taylor, chief investment officer at Purpose Investments Inc. in Toronto, noted recently that during the pandemic companies were seeing revenues grow by 50% a  year as they pulled normal growth forward.  “That’s not sustainable,” he said. 

He added that the best of the bunch will continue to succeed.  Zoom, for example, has a good business model  and “has become an  essential tool for so many people. It’s just got to figure out a way to keep growing.”

Stick to the plan

The strategic plan is a decision-making anchor that helps put day-to-day noise in perspective. These goals, developed with your advisor, will determine your asset mix, the need for growth versus income and tolerance for risk.

Jack Bogle, who founded the Vanguard family of funds called ‘The Plan’ the way to “Buy right and hold tight.”

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Adam Mayers writes about investing and personal finance. He is a contributor to the Globe & Mail’s Globe Advisor and a contributing editor to Gordon Pape's Internet Wealth Builder newsletter. Adam was Business Editor and investment columnist at The Toronto Star and is the author of six books.

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