In May, a basket of unprofitable technology stocks tracked by Goldman Sachs surged 27%, outperforming the Nasdaq 100 Index by 17 percentage points, marking the largest monthly excess return since November 2020. Year-to-date, this portfolio has climbed 57%, while the S&P 500 Index has gained only 11% over the same period.
This strong performance has been primarily driven by the market's most speculative tech stocks, including space and satellite company NextNav, small AI firm BigBear.ai, and drone manufacturer Unusual Machines. Among them, Unusual Machines more than doubled its share price in May.
However, following such a rapid ascent, several Wall Street institutions are beginning to issue warnings to investors. The JPMorgan Market Intelligence team, led by Andrew Tyler, notes that given the potential for bond yields to remain elevated, investors should be wary of the riskiest segments of the tech sector. The firm advocates shifting capital towards higher-quality large-cap stocks within the industry, as share buyback activity by large, profitable tech companies helps drive a rotation into quality.
Mark Hackett, Chief Market Strategist at Nationwide, states that the forces driving unprofitable tech stocks higher show significant overlap with baskets of stocks favored by retail investors, reflecting a mindset of seeking the highest leveraged exposure during market rallies. Kieran Osborne of Mission Wealth Management cautions against interpreting the recent gains as a signal that unprofitable tech firms possess long-term appeal, warning there will be winners and losers, and it's difficult to distinguish between them.
Counterintuitive warnings also exist: Hackett points out that share prices for these companies often fall once they start turning a profit, because there is then a real basis for valuation. Jonathan Golub of Seaport Global adds that even large tech companies face pressure from rising Treasury yields as they take on significant debt to build AI data centers.
Some unprofitable tech stocks still have fundamental support. BigBear.ai's first-quarter revenue of $3.44 billion slightly exceeded expectations, its backlog grew 14% to approximately $282 million, and its gross margin improved significantly from 21.3% to 34%. The company also secured several new contracts, including a $53 million deal with the intelligence community. However, the company remains deeply unprofitable, reporting a quarterly net loss of $56.8 million.
Michael O'Rourke, Chief Market Strategist at JonesTrading, concludes: "The across-the-board rally we are seeing in the technology sector is itself a reason for caution. And the non-profitable tech stocks are just taking that risk to a higher peak."
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