It has been a spectacular display, provided you are watching from a safe distance.

The gravity-defying tech sector reached nosebleed altitudes during the height of the pandemic. But momentum stalled out last year, and these former highfliers are now hurtling back towards Earth.

The old adage “what goes up, must come down” doesn’t always play out in the investment world. But more often than not, it does ring true. And that’s what we’re witnessing right now.

I Saw This Coming…

Over at my High-Yield Investing premium service, we’ve talked at length about the market’s longstanding disdain for value and love for all things growth. Okay, bemoaned might be a better term. Either way, that’s been the general behavior exhibited ever since the 2009 recession. But this dominance became even more exaggerated during the era of lockdowns and social distancing restrictions.

The tech sector accounted for eight of the ten biggest S&P winners in 2020. You can probably guess some of the names. Paypal (Nasdaq: PYPL) surged 116%. Chipmaker Nvidia (Nasdaq: NVDA) returned 122%. Tesla (Nasdaq: TSLA) rocketed 743%.

That means the other ten major market sectors combined (from industrials to healthcare) fielded just two names on the leaderboard. Considering the innumerable ways in which the pandemic fundamentally changed our daily lives, you can understand why investors flocked to this group and ignored most others.

If you were loaded down with these stocks, those were good times. But for the rest of the market? Not so much. Unfortunately, that kind of concentration can be dangerous.

Consider these comments I made back in September 2020 to my premium readers:

Tech brethren now account for nearly 30% of the S&P index weighting. Let me put that in perspective. The utilities, energy, real estate, and consumer staples groups account for just 16% combined. That means tech has twice as loud a voice as these four sectors put together.

I tend to be leery of narrow market leadership, as it often foreshadows market corrections. Investors have been chasing momentum wherever they can find it with little regard to price. Without naming names, the five largest stocks now account for more than 20% of the market, exceeding the former high of 18%.

Care to guess when that occurred? March 2000, just before the dot-com crash.

That prediction didn’t happen right away. In fact, giddy tech investors continued to watch their shares rally for another six months. But then, as the world began to emerge from Covid hibernation in February 2021, market sentiment suddenly started to shift in a big way.

Here is one of my observations from a few weeks later:

The prospect of higher borrowing costs has cooled the scorching rally in the most explosive sectors of the market — namely technology. The tech-heavy Nasdaq has lost ground in 9 of the past 13 trading sessions. Since the peak on February 12, Apple has shed about $270 billion in market cap. Overall, the Nasdaq 100 Index (a proxy for the tech sector) has collectively lost $1.6 trillion (with a “t”) in just three weeks.

Clearly, cracks were already starting to show in the foundation. Investors were finally cashing out their tech profits and looking elsewhere.

All that cash had to go somewhere. At long last, value and dividends started to come back into favor. That’s partly because relative valuations between these two classes had become skewed to unprecedented levels. You could argue (and I did) that this reversal was long overdue.

This Sort Of Thing Is Actually Healthy…

We all know what has happened since then. While dividend-oriented stocks stood their ground during the past couple of months, it was a disastrous start to 2022 for the tech sector, which continues to hemorrhage market cap.

Let’s revisit a few of those names cited above.

After peaking north of $300 less than a year ago, Paypal is in danger of sliding back below $100. The stock suffered its worst daily loss on record earlier this month, losing a quarter of its value after issuing a disappointing outlook and backtracking on some of its user growth projections.

The very next day, Facebook parent Meta Platforms (Nasdaq: FB) endured a punishing 27% collapse, which erased $237 billion in market cap. For perspective, that loss is greater than the entire market value of all but 30 members of the S&P. Again, the historic setback — the largest for any stock in U.S. history — was triggered by declining profits and an unexpected drop in the number of Facebook users.

These are by no means isolated examples.

DocuSign has retreated from above $300 to below $120. Netflix, which changed hands at $700 just a few months ago, is now below $400. Teladoc (Nasdaq: TDOC), a pandemic darling whose platform enables patients to consult virtually with their doctor, has skid from nearly $300 to less than $70.

Throw a dart randomly at a stock chart in this corner of the market, and it’s probably ugly.

Gravity had to re-assert itself sooner or later. And personally, I’m glad it did. The market is healthier when stock prices are at least loosely connected with the underlying company and industry fundamentals. But after having a front-row seat to the first dot-com meltdown, I don’t see this correction as a second one.

Sure, there are certainly some parallels with regard to extreme valuation. There are also some behavioral similarities, with investors (speculators, really) buying whatever is hot in the hope of unloading it to the next guy at an ever more ridiculous price. A day of reckoning had to come.

But here’s the difference: this time around, we’re not dealing with unproven startups.

Many of these names are proven, cash-generating business models.

Netflix pocketed more than $6 billion in operating cash flows last year from its 200+ million paid subscribers, an increase of 35%. Teladoc reported sizzling 80%+ top-line growth last quarter, facilitating nearly 4 million virtual healthcare visits. Yet, Teladoc has lost every single penny of its Covid-related gains and then some.

Others have retreated back below their initial IPO price.

Closing Thoughts

So where does that leave us? Well, I don’t want to paint with too course a brush. Some valuations were so egregious that even after a 50% decline, the stocks are still overpriced. But after months of indiscriminate selling, bargains have started to emerge…

That’s not to say that the sun will come out tomorrow and these stocks will immediately return to their former highs. But with a couple trillion in market cap wiped out, the excess froth has been removed from the market and this group is priced more attractively than it has been in recent memory.

I hate to use an overdone analogy. But after one heckuva wild party, a hangover was inevitable. Now, it’s time for a sober assessment of the potential bounce-back candidates, some of which have considerable upside potential.

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