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Tech Stocks: Did The Momentum Rally Just Die?

By Alex Dumortier, CFA – Mar 24, 2014 at 7:00PM

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Facebook, Tesla Motors, and Netflix underperform -- that could continue.

Although stocks opened higher this morning, that didn't last beyond the first half-hour of the session and the benchmark S&P 500 ended Monday's session down a half-percent. The narrower Dow Jones Industrial Average (^DJI 0.38%) fell just 0.2%, but it was the technology-heavy Nasdaq Composite Index that had the roughest time of it, losing 1.2%. Some high-profile growth names fared even worse, as Facebook (META 0.25%), Tesla Motors (TSLA 0.85%) and Netflix (NFLX 2.76%) lost 4.7%, 3.8% and 6.7%, respectively. The three are some of the market's best-performing shares over the past 12 months -- the vanguard of a rally that has certain segments of the technology sector looking overheated ... and rather precariously perched. Does today's action forebode a more serious correction in these shares?

Ukraine as an excuse
Pity the financial journalist who is tasked with finding an explanation for the market's movements on a daily (or hourly!) basis. "Tech leads Wall Street lower as Ukraine casts a shadow," reads the Reuters headline this afternoon, with the article explaining that "concerns that the crisis in Ukraine could escalate gave investors a reason to drop some of the market's biggest trading favorites."

Perhaps "investors" did sell growth names in reaction to today's news out of Crimea; but if they did, that action has little or nothing to do with a fundamental case for these businesses. Ask yourself: What is the business exposure of Facebook or Tesla Motors to Ukraine or Russia?

For traders and momentum chasers, there is a better case for selling on raised global macroeconomic and political risks -- if the markets experience a broad reversal in risk appetite (remember "risk on/risk off"?), high-flying shares are the most exposed. However, it's not clear that this is what happened today; after all, the VIX (^VIX -0.58%), the most widely followed gauge of fear, hardly budged at all, gaining just 0.6% to close at 15.09 -- significantly below its long-term historical average.

Watch out for the sharp end of the spear!
Instead, it looks like the reversal in risk appetite was concentrated at the tip of the spear -- technology shares that have had huge run-ups with resulting valuations that look disconnected from their fundamentals. At 50 times the next 12 months' earnings per share, Facebook is the most reasonably priced (on traditional metrics) of the three stocks I mentioned in the opening paragraph, but it also sports the highest market capitalization -- 50 times forward earnings is a heck of a price tag for a business that's already worth more than $160 billion. As for Netflix and Tesla Motors, even their CEOs have expressed concern that their shares are overpriced.

Is biotech an early warning?
Another high-flying sector, biotechnology, appears to be experiencing the same phenomenon, only more so. The Nasdaq biotechnology index, which rose by two-thirds last year, lost 3% today -- its fourth consecutive daily loss. Today's loss puts the index's cumulative decline from its Feb. 25 peak at 12.4%, which means it's already in correction territory. While short-term predictions are a mug's game, it's clear the same thing could easily happen to other technology shares that have put up outsized gains over the past year (or less -- some of the names haven't even been public for 12 months).

Alex Dumortier, CFA, has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Facebook, Netflix, and Tesla Motors. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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