Tech Stocks: Why the Selloff Could Get Worse

Tough sledding. Aivars Lode

By Dan Gallagher and Justin Lahart

Dark clouds have descended on the tech sector. And while Punxsutawney Phil may say otherwise, a break may not be soon in coming.

A bruising selloff since the first of the year has cost the Nasdaq Composite all of its gains since late 2014, with the pain particularly acute in the riskier Internet and software sectors. The index is off 14% so far this year. The Nasdaq Internet Index has fallen 21%, and cloud stocks tracked by the BVP Cloud Index are off more than 31%. By contrast, the Dow Jones Industrial Average is off a more modest (even if still painful) 8%. 

The selloff reflects an unsettled global economic and financial-market environment that is hitting tech stocks on three fronts.

First, in an era when U.S. companies at large have become steadily more dependent on their foreign operations for sales, tech companies’ overseas exposures stand out. Hewlett-Packard, for example, generates only about a third of its sales in the U.S, while Intel books less than a fifth of its sales domestically. As a result, many tech companies are taking unusually hard hits from economic weakness abroad. The dollar’s strength against other currencies—the greenback averaged 12% higher on the year on a trade-weighted basis versus other currencies in the fourth quarter—has made a bad situation even worse.

Second, worries about the global economic environment have prompted many companies to rein in capital spending and other investments. This can hurt the flow of new deals that is the lifeblood of software companies that sell cloud-based services. Tableau Software trimmed its full-year forecast last week, citing “softness” in business-tech spending. That sparked a huge selloff that cut Tableau’s market value by more than half and badly damaged many peers. Salesforce.com, Workday and Splunk—which will report results later this month—are off more than 20% in just the past two sessions.

Finally, there is the issue of price. Most cloud and Internet companies carry lofty valuations. Amazon.com is still more than 100 times forward earnings despite losing nearly 30% of its value since the first of the year. The Nasdaq Composite still carries a premium of nearly 24% to the S&P 500 on the same basis.

Now, the benign economic environment those valuations were predicated on has been put into question, while a global flight to safety has pushed investors away from risky bets.

With the tech sector’s earnings season still in full swing, it is possible that pending reports could help turn the tide for the sector. Cisco Systems is slated to report Wednesday, and that company often serves as a barometer for corporate-technology demand.

The problem is, tech’s earnings reports have actually gone pretty well so far, relative to reduced expectations. But that hasn’t stanched the bleeding.

About 65% of reporting tech companies have also exceeded analysts’ revenue targets, compared with 49% for the S&P. Not that it has done them much good: Microsoft and Google are down 11% and 12%, respectively, since their relatively strong reports.

In the changed market environment, the tech sector has caught a sudden chill. Spring, especially for companies with little in the way of profit, will be a long time in coming.