Beware a valuation squeeze in tech stocks, strategist warns

Independent Wealth Solutions Management's Paul Meeks joins Yahoo Finance Live to discuss tech growth for 2023, tech stock valuations, layoffs, and the expectations for earnings.

Video transcript

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JULIE HYMAN: And as we continue to look ahead to big tech earnings this week and to the Federal Reserve raising interest rates this week, let's bring in Paul Meeks, Independent Wealth Solutions Management Portfolio Manager. And, Paul, thank you very much because you were helpful to me yesterday as I was sort of formulating my thoughts around this topic. So we've got these two coincident events this week with big tech earnings and the Fed raising interest rates. Which is going to win out? Is it going to be fundamentals with some of these tech stocks or is it going to be rhetoric from the Fed?

PAUL MEEKS: I think it's the latter because what has driven these stocks up and down, as you've said, is interest rates, whether they, in the bull market, were ultra low and now they're starting to feel some pressure on the upside because here's the problem. Some of these tech stocks, even though they might have come down a whopping 60% or 70% last year on a absolute and even a relative basis, they're not particularly cheap. They're not bare bones cheap. And so if they're going to do well going forward, yes, we have to have some improvement in the fundamentals.

And as we circle through a recession, which I think is going to be pretty short and shallow, we will have somewhat of an improvement. But if we have a terminal rate for the Fed's fund rate that is plateauing over 5%, which I think it actually will-- I don't believe in the pivot, at least not in 2023-- you are going to continue, regardless of any rebound in earnings, to have a valuation squeeze on some of your favorite tech stocks because they still may be trading at 20 or 30 times, even though at one point they were trading at 60, 70, 80 times. So I actually think it is the key factor and one of the reasons that I remain at least modestly bearish on the tech sector.

BRIAN SOZZI: Paul, what names might get squeezed further from a valuation perspective?

PAUL MEEKS: I think, Brian, the ones that are particularly expensive. You know, I know everybody wants to pile back in into something like an Nvidia. You know, Nvidia, in the age of artificial intelligence, obviously the play, probably no question about that. But the ones that have very high valuations, still have very high valuations, I think are somewhat at risk.

And then, of course, you have the companies that were really COVID beneficiaries. They benefited from things like remote work. They never had great cash flow forecasts. They were what I call profitless prosperity companies that are all revenue and no cash flow or earnings growth. Those could be squeezed a hell of a lot more.

BRIAN SOZZI: Paul, you know, Julie was just breaking down how rates impact tech stocks. But has execution or lack thereof also play a role? We came on air-- just before we came on air, we got news of NetApp laying off 9% of its workforce, Workday 3% of its workforce. And that's a terrible job by these guys. They couldn't forecast any of this?

PAUL MEEKS: You're absolutely right. What happens is they get so caught up in that feast and famine routine. You think that with a close look at their businesses, they wouldn't have hired so many people. I think they hired people with the false belief that COVID was the new normal and we wouldn't actually morph back into something more normalized like we had prepandemic And so, yes, you know, somebody like Amazon has fired 18,000 people. I know that sounds like a big number, but they have a million and a half employees.

And so what I'm worried about, Brian, is as we get through these quarterly earnings, and as we go through into the March quarter, the June quarter, particularly the September quarter, we start to roll into a recession, then you might have layoffs that make the current layoffs look like child's play. I think they may have to lay off many more folks. And that's, unfortunately, very sad for those people.

BRAD SMITH: Paul, there are some parts of the consumer environment right now that are already feeling what a recession could look like. And you think about some of the lower-income households and how that may even permeate over if we do see more of the employment situation start to sputter, or at least add on some more of the layoffs that you're talking about or forecasting, what that may actually look like and transpiring through to some of even the largest-cap company names that we were talking about in tech a moment ago.

PAUL MEEKS: Yeah, you think about it, consumer electronics has already really felt the pinch. We've seen a big drop off globally in smartphone units, and we've seen a bigger crash in PC units. And I don't expect those markets necessarily to rebound so quickly. So be wary of your favorite tech stocks, particularly if they're still relatively and absolutely expensive that are focused on consumer electronics because that's all about discretionary spending.

And then on the enterprise side of the house, we've seen it time and time again, something like a salesforce.com, they see their enterprise customers really pulling back as well. So I worry about those very pricey software companies, and I worry about, on the consumer side, those folks that are dedicated to consumer electronics.

JULIE HYMAN: Good warnings, for sure, and cautions. Paul Meeks, great to talk to you, as always. Independent. Wealth Solutions Management Portfolio Manager. Thank you, Paul.