A rally in technology shares helped the stock market snap a three-week losing streak. There are already signs that reprieve may be short lived.
Investors are bailing out of technology-focused mutual and exchange-traded funds at the fastest clip since early February, when the tech selloff was first intensifying, according to data from Refinitiv Lipper. They yanked about $2.4 billion from such funds in the three weeks ended Wednesday.
The group has been among the hardest hit since the early summer stock-market rally fizzled amid dimming hopes for a pivot by the Federal Reserve. Last week, clues on the central bank's interest-rate path continued to drive big swings in stocks -- as of Tuesday, the Nasdaq Composite was in the midst of a seven-session losing streak, its longest since 2016, before it rocketed higher over the following three days.
Even after rallying 4.1% this past week, the tech-heavy gauge is still down around 3.1% over the past month, underperforming the S&P 500, which is off 1.3%. In 2022, the Nasdaq has fallen 23% and is headed toward its worst annual performance relative to the broad benchmark since 2002.
"It's a volatile year -- it's never easy to sound the all clear from a short-term basis," said Giorgio Caputo, a senior fund manager at J O Hambro Capital Management Group.
Still, Mr. Caputo said he thinks the entry point to pick up tech shares is better now than it was earlier in the year.
In the coming week, traders will be closely parsing fresh data on consumer prices for clues on the path of interest-rate increases, a report that could stoke giant moves across stock and bond markets.
Tech stocks have been more susceptible to rapidly shifting sentiment in the bond market -- which is in one of the most intense downturns in decades -- than many other corners of the stock market. That is in part because rising yields make their future cash flows less attractive and have led many investors to flee the shares.
Even after the downturn this year, many analysts say tech stocks still appear richly valued. Apple Inc., Microsoft Corp., Alphabet Inc., Amazon.com Inc., Tesla Inc., Meta Platforms Inc. and Nvidia Corp. have on average a forward 12-month price-to-earnings ratio of 38, compared with 16.7 for the S&P 500, according to DataTrek Research.
"If you expect that there's going to be stiff economic headwinds and realize that the Fed is in inflation fighting mode, those valuations are still at risk of coming lower," said Jake Jolly, senior investment strategist at BNY Mellon Investment Management, which oversees about $1.9 trillion in assets, of tech stocks.
Many traders expect the Federal Reserve to raise interest rates by 0.75 percentage point for the third consecutive time at its meeting later this month as it looks to combat sky-high inflation.
Analysts have taken an especially aggressive hand with companies in the tech sector when evaluating their earnings estimates.
Expectations for third-quarter earnings within the S&P 500's information technology and communication services sectors -- home to the parent companies of Facebook and Google -- have fallen by about 9% and 13%, respectively, over roughly the past two months. Those are the steepest declines among any of the groups in the index, FactSet data show. Analysts have slashed their estimates on everything from Twitter Inc. to Meta and Alphabet.
An options measure called skew, which measures how costly it is to protect against further stock declines, is elevated for stocks such as Microsoft, Amazon, Meta and Nvidia, according to Charlie McElligott, a managing director at Nomura Securities International. That is typically a sign that some traders are positioning for a bigger drop.
Meanwhile, semiconductor stocks, such as Nvidia and Advanced Micro Devices Inc., have faced some of the most acute pressure of late. Both stocks have tumbled more than 10% over the past month, a slide that has erased tens of billions of dollars in market value.
"We continue to believe we are entering the worst semiconductor downturn in a decade given the recession and inventory build," Citigroup analysts wrote in a note to clients on Aug. 30. The analysts projected that the PHLX Semiconductor Index would fall another 25%.
The underperformance in tech is bad news for the broader market, which is closely correlated to the group's performance. The S&P 500 is weighted by market cap, and most of its biggest constituents remain in the tech industry.
The recent selloff -- and late-week rally in tech -- has led some investors to question whether the worst of the declines are over after an already punishing year. Much of the debate around tech's performance hinges on the path of Treasury yields in the coming months.
If inflation keeps falling and economic growth flounders, that could be a boon to the sector, especially if the Fed eventually eases up on raising interest rates, some investors said.
Goldman Sachs analysts recently suggested that could lead to a repeat of 2019, when shares of growth stocks outperformed their value counterparts as the Fed shifted to cutting rates after steadily raising them. That said, the bank said it is still expecting shares of value companies -- traditionally considered those that trade at a low multiple of their book value, or net worth -- to shine.
Some investors have gone hunting for bargains, positioning for a rebound. One fund that provides turbocharged exposure to the Nasdaq-100, the ProShares UltraPro QQQ, recently recorded its biggest one-day inflows since early June, FactSet data show.
Christopher Grisanti, chief equity strategist of MAI Capital Management, said his firm trimmed some of its tech positions earlier in the year. Now, after the continued selloff, he thinks several companies in the group, including Alphabet, look attractive.
"If you want to pick the best house to buy in this crummy neighborhood that's the market right now, I think tech is looking relatively attractive," Mr. Grisanti said. "Should we roll into a recession, they'll lose me less money than other things."