Vanguard Information Technology ETF (NYSEARCA:VGT) lost about 30% of its value in 2022, and I expect it to lose even more in the first half of 2023. Factors such as an earnings recession and high valuations may extend the tech selloff into the coming months. Furthermore, tightening monetary policy combined with an impending recession would also affect stock prices and investor sentiment. Dip-buying, in my opinion, makes more sense by the end of the first half of 2023 or early in the second half, when tech stocks are likely to have fully realized the impact of negative factors such as earnings decline, Fed tightening, and slow economic growth. Additionally, a favorable economic environment and higher corporate profitability in the second half of the year may spark a new phase of stock market recovery.
The Earnings Recession is the Biggest Headwind
Share prices have always been sensitive to revenue and earnings trends. Tech stocks, in particular, must demonstrate strong growth patterns to attract investors and justify premium valuations. In 2021, growth stocks rallied as tech products and services were in high demand. However, VGT’s share price lost over a quarter of its value in 2022 due to slowing earnings growth rates. It’s true that the deceleration in earnings growth has already had some effects on tech stocks’ performance in 2022, but the real impact is yet to be felt in the first half of 2023. This is because earnings for the fourth quarter and 2023 are likely to fall at a higher rate than previous expectations.
For instance, the most recent FactSet estimate shows that the S&P 500’s fourth-quarter earnings will drop 4% compared to the same time last year, which would be the first decrease since Q3 2020. I believe the market will factor in the impact of a significant drop in fourth-quarter earnings when companies actually report them later this month and in February. Moreover, Morgan Stanley and JP Morgan analysts predict earnings could fall at the fastest rate in two decades in 2023, with the majority of the decline expected in the first half of the year.
In particular, growth stocks in the information technology sector could have a tough time ahead. This is because earnings for the information technology sector are likely to decline by 9% year over year for the fourth quarter. VGT’s top ten holdings, which account for roughly 60% of its total portfolio, also reflect the bleak earnings outlook of tech stocks. As an example, Apple (AAPL) is expected to report a 6% drop in quarterly earnings for the December quarter, followed by a low-single-digit decline in the first quarter of 2023. Microsoft (MSFT), VGT’s second-largest holding, also earned a negative D on the earnings revision, as all 30 Wall Street analysts have lowered their earnings forecasts for 2023. Similarly, earnings forecasts for the rest of VGT’s top software and semiconductor stock holdings fell significantly in the last 90 days.
Valuations Risk Is Increasing
The information technology sector’s forward price-to-earnings ratio fell sharply in 2022 due to a steep drop in share price. Despite that, technology stocks are still trading well over the S&P 500’s forward PE ratio of 16.7. Furthermore, declining earnings estimates limit tech stocks’ upside potential. This is because stocks become instantly expensive when their prices rise without being supported by earnings growth. In addition to forward earnings, the majority of VGT’s portfolio holdings received a low quant score on valuations from the Seeking Alpha quant system. For example, the valuation of its top five holdings, which include Apple, Microsoft, Visa (V), Mastercard (MA), and NVIDIA (NVDA), received an F grade.
Interest Rates and Recession
The risk of rising interest rates and a recession, which were key drivers of the tech stock downtrend in 2022, is likely to persist in 2023. At its most recent meeting, the Fed slowed its rate hike campaign but gave a hint that the final level would be higher—more than 5%, as opposed to earlier projections of 4.65%. High interest rates are bad news for risky assets and growth stocks, which rely heavily on economic growth trends and easy borrowing policies. On the other hand, one of the most rapid rate hikes in decades is likely to push the US economy into recession. According to the Survey of Professional Forecasters, US GDP is likely to grow by 0.8% in 2023, compared to forecasted GDP growth of around 1% in 2022 and 5.7% in 2021.
It appears that the US economy could enter a recession in the third quarter of 2023. Interestingly, the historical trends show that stocks perform worse six to twelve months before a recession than they do during the recession. It is therefore wise to hold off on dip buying until stocks fully realize the effects of economic headwinds in the first half.
Quant Ratings
It is wise to evaluate an investment using quantitative analysis because real database analysis takes emotions out of the equation and offers a more impartial viewpoint. According to Seeking Alpha’s quantitative analysis, VGT has received a sell rating with a quant score of 1.91. It scored poorly on momentum, risk, and asset flows. Low scores on momentum and asset flows indicate the stock has little room to rise. Moreover, the D+ score on the risk factor also indicates a downside risk. Besides high standard deviation and volatility, an earnings recession, high interest rates, and an economic meltdown also pose a high risk to the ETF.
In Conclusion
Investing in a technology-related ETF like VGT right now might not be a good idea because its share price is at high risk of further declines in 2023. Instead, dip buyers should wait for a buying opportunity late in the first half or early in the second half of 2023, when the market fully realizes the impact of earnings declines and an economic slowdown. Additionally, the Fed would have reached its peak by then, and it might be obvious when a pivot will begin.
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