Q2 Saw Tech Turbulence as Workers Sheltered at Home

Editor’s note: Read the latest on how the coronavirus is rattling the markets and what investors can do to navigate it.

Brian Colello: Similar to the broader market, technology stocks have been on a wild ride over the past six months. As of June 5, the median technology stock is about 8% overvalued, in our opinion. Now, at the start of 2020, prior to the COVID-19 pandemic, the median tech stock was about 11% overvalued, and valuations were as frothy as we've seen since 2007. Now, with the sell-off at the end of March, at the depths of the COVID sell-off, tech was 20% undervalued. So, the sector has really rallied back to again now be 8% overvalued.

Comparing tech to the broader market, tech is a clear outperformer. Over the past 12 months, again, as of June 5, tech is up 37.6% while the U.S. equity market index is up only 12.5%. We've seen a big rally in software names, and some tech firms have been countercyclical to the market and have been winners in this work-from-home trend.

The median software stock is 11% overvalued, but business conditions have held up relatively well. Growth will somewhat be slower in 2020 as you'd expect, but we think business conditions bounce back in 2021. Employees still need access to the software while working from home. Remote working will likely continue to be adopted, which is good news for companies like Zoom, Microsoft, Slack, DocuSign, and some others, but we think valuations are rich.

Cybersecurity is also seeing a boost in spending, especially for cloud vendors like Zscaler, Okta, and CrowdStrike. Across technology, we think hardware names are a little bit cheaper, but generally aren't as moaty and don't have the sustainable competitive advantages that we see in higher-quality software or semis or cybersecurity. Those names are a bit expensive, but names that we do like are Palo Alto Networks, VMware, and Cognizant Technology Solutions.

Looking ahead at earnings reports in July, we'll be keeping an eye on business conditions in software and cybersecurity. We'll be looking for any signs of delays, deal cancelations, lower pricing, anything of that nature. In semiconductors, some end-markets have been strong. Others have been soft. Data center spending has been a bright spot, and we'll see if that continues.