The sector has become a major weighting in many smaller company funds in particular as well as global growth funds as investors look for companies able to grow their businesses in a sluggish economy.
However, many analysts and managers have warned on valuations in the sector and suggested they could be due a fall, and recent events suggest this could be happening.
Last week the flying internet stock ASOS saw its share price fall 20 per cent after announcing growth that was slightly down on expectations. It is now down 28 per cent over the past month.
Internet food retailer Ocado is also down 28 per cent over a month, after its annual results showed it is yet to turn a profit, while AIM star software company Quindell is down 22 per cent from its peak.
Performance of stocks versus FTSE over 1yr
Source: FE Analytics
The US biotech sector has also started to roll over, with the NASDAQ Biotech index down 8.74 per cent over a week.
Performance of indices over 1yr
Source: FE Analytics
Biotech-focused investment trusts have been some of the fastest-rising on the market, with the Biotech Growth Trust up 196.55 per cent over just three years.
However, the sector has taken a hit after Gilead Sciences, one of the most popular stocks among managers on the index, was served with a letter from the US FDA querying the pricing of its drugs.
Tim Gregory, head of equities at Psigma, says that the falls on that sector were overdue and he is still steering clear on valuations grounds.
“Valuations have got ridiculous,” he said.
Gregory says that investors can benefit from the demographic and political trends supporting healthcare spending in more orthodox areas such as the undervalued large-cap UK stocks AstraZeneca and GlaxoSmithKline.
FE Alpha Manager Julian Lewis, who runs the Cavendish Balanced Income and Cavendish Worldwide funds, is maintaining his position in Gilead, however, which is worth 1.2 per cent of the Cavendish Worldwide fund.
Lewis (pictured) says that the concern with that company is that the US starts to bring in price controls for drugs, but he doesn’t think that is going to happen.
The manager thinks that it is in a good position despite falling 7.8 per cent since the market started to sell off. He is far more sceptical of the internet stocks that have suffered, however.
“ASOS we don’t hold it but it’s one we follow,” he said. “I would be cautious the fact is UK sales for ASOS came in lower than expectations.”
“The danger with a stock like ASOS is it cannot keep growing stratospherically for ever – no stock can do 20 per cent earnings growth a year for ever. The market isn’t big enough.”
Lewis warns that a company often reaches saturation point in its market before investors realise.
Another UK tech stock to have suffered in recent months is software company Blinkx. Shares in Blinkx are down over 50 per cent since allegations of click fraud were aired in the US by a professor at Harvard Business School. Lewis bought the stock before the allegations surfaced.
Performance of stock in 2014
Source: FE Analytics
“Blinkx we see as a one-off,” Lewis said.” It will be interesting to see what they’re next results say.”
Lewis notes that the professor admitted to having being paid by two large US investors, and that there was a large short position in the stock which will have benefitted from the furore.
However, he acknowledges that the actual process whereby companies like Blinkx operate and gets revenue is opaque, which makes it hard for managers to take a position on such matters. Managers from BlackRock, the largest shareholder in Blinkx prior to the falls said the same to FE Trustnet.
This does suggest that investors are so keen to buy potential growth that they are buying speculative or difficult to value companies.
Lewis hints at this when he says that the current problems in tech stocks are indicative of a problem with finding growth in equities in general.
“The era of cheap growth stocks is probably over,” he said. “We have been quite spoilt really since 2009. As the market was very risk averse you could buy good quality stocks with good growth prospects at attractive returns.”
“Nowadays it’s really difficult wherever you go. We have been looking in the US, Chia India, it’s very difficult to find stocks with 20 per cent earnings growth and a P/E under 20.”
“Typically they are in the 20s with a PEG ratio [P/E divided by growth] of over 1 whereas we have been used to seeing those below one.” [ A lower PEG ration would be considered better.]
“I think people are paying up for growth and conversely if they see any weakness they are prone to dumping the stock quickly. This tends to be a good buying opportunity.”
This raises the possibility that the problems in the tech sectors are just the same issues facing the markets as a whole: companies that are slightly off target are being battered.
BG Group was the latest to see significant falls after production guidelines were reduced. Tate and Lyle and Rolls Royce have suffered similar shocks.
With the tech sectors having risen so fast over the past year maybe the companies that disappoint simply have further to fall.
