META - Top Analyst Calls For 15% Tech Stock Rally Here Are 2 Sectors I Like More

2023-10-24 11:20:13 ET

Summary

• Wedbush Securities analyst Daniel Ives predicts a tech stock rally by the end of the year. The rally, according to the analyst, will boost tech stocks by 12%-15%.
• As an investor with substantial exposure to the tech sector, I would happily welcome such a development. However, I believe there are other sectors that look more appealing.
• To evaluate the prospects for tech stocks, investors need to understand where inflation is headed.
• According to Morningstar, U.S. stocks are once again valued attractively after reaching fairly valued territory in July.

Wall Street analysts are human. If we are ready to cut some slack whenever a billionaire investing guru - let's say Warren Buffett for example - commits a mistake, we need to be ready to forgive Wall Street analysts when they make mistakes too. Unfortunately, though, analysts are seen as a group of market participants who are not allowed to make mistakes. Following them blindly will take us nowhere as investors, but there is no harm in keeping a close eye on at least some of these analysts to potentially uncover hidden gems in the market and stay on top of developing market trends.

Wedbush Securities analyst Daniel Ives has a good reputation for uncovering hidden gems in the tech sector. Some of his best-performing recommendations are small or medium-cap stocks, which is one of the main reasons why I follow the analyst. Based on the rating system of TipRanks - take these rankings with a grain of salt - Dan Ives is among the top 120 Wall Street experts based on the performance of his ratings in the last 12 months.

In recent times, the analyst has been calling for a major tech stock rally toward the end of the year. Last August, the analyst said :

We firmly stick with our bullish call that a 12% to 15% [rally] in tech stocks will be in the cards heading into year-end as the new tech bull market has begun.

Dan Ives's confidence in tech stocks primarily stems from his bullish stance on the AI sector. Explaining the reasons behind his call for a tech stock rally by the end of this year, Ives said:

AI remains in the spotlight-driving success for some and headwinds for others. From the hundreds of conference calls we listened to over the past month it's clear that the AI theme is changing the enterprise and consumer landscape going forward and creating a bifurcated spending environments for the winners and losers in this backdrop.

From a sector breakdown, Ives believes cloud computing, cybersecurity, and digital advertising sectors will perform the best. Below are two of his top picks to make the most of the tech stock rally that he is calling for.

1. Consensus Cloud Solutions (CCSI).
2. Pegasystems Inc. (PEGA).

Dan Ives has a solid track record in identifying undervalued tech stocks, but as investors, we need to dig deeper into the dynamics of the information technology sector before betting on any new tech stocks at a time when macroeconomic pressures continue to linger.

A good starting point for this analysis is a discussion of the recent trends in inflation.

The Fed May Be Forced To Hike Rates Again

Inflation has meaningfully cooled down this year amid a concerted effort by monetary policymakers to curb surging prices. However, inflation still remains above the Fed's target of 2%, and September data adds a new layer of complexity.

In September, core inflation came in at 3.7%, matching the CPI increase in August. Economists polled by Bloomberg were expecting the CPI to increase at a slightly lower rate compared to August, which gives reason to believe we are not fully out of the woods yet. Core inflation, which removes the impact of energy and food prices, rose 4.1% in September, which was an improvement from 4.3% a month ago. Core inflation was helped by a notable decline in energy prices, but with the ongoing tensions in the Middle East, energy prices are likely to remain elevated in the coming weeks. If tensions escalate, impacting oil production in the region or even distribution to other parts of the world, energy prices will almost certainly surge, creating a massive impact on the CPI in the next few months.

Exhibit 1: YoY change in the CPI and core inflation

If inflation persists at elevated levels, the Fed will have no option but to continue its fight against surging prices. Recent strength in the job market also adds to the pressure on inflation. Despite a series of aggressive rate cuts, the job market remains strong. In September, the unemployment rate remained unchanged at 3.8% and non-farm payrolls grew by 336,000. The continued strength of the job market suggests we are most likely headed toward an expansionary phase of the business cycle - not a recession. As illustrated below, non-farm payroll additions have gathered pace in the last few months.

Exhibit 2: U.S. non-farm payroll additions

Although the Fed's objective is not to push the U.S. economy into a recession, a notable slowdown in the economy is needed to put breaks on inflation.

Many market participants were hopeful for a rate cut by the end of the year, which is increasingly becoming unlikely amid continued strength in the labor market and the prospects for higher oil prices in the foreseeable future.

As you know, tech stocks are highly sensitive to interest rates. Expectations for a less aggressive Fed have played a major role in improving the market sentiment toward tech stocks this year. Although Dan Ives is calling for tech stocks to rally by the end of this year, I believe the odds are not as favorable as they seem at first given the recent macroeconomic and geopolitical developments.

I am not ruling out the possibility of a tech stock rally, and as many of you know, I continue to invest in tech stocks and I have no intentions to avoid tech stocks given that I enjoy an extensive investment time horizon which helps me take calculated risks to invest in growth companies. That being said, I hold the opinion that investors should not go all-in today amid a challenging backdrop for tech stocks.

Tech Stocks Remain Expensive But The Recent Sell-Off Has Created Opportunities

2022 was a disappointing year for stock investors. On the back of a lackluster performance, 2023 started with stocks looking extremely attractive across the border. However, the broad market rally in 2023 (S&P 500 is up 14.3% YTD) has pushed stocks more toward the fairly-valued territory. But, the market selloff that began in July has once again created some opportunities for investors to exploit. According to the Morningstar market fair value index, U.S. stocks were almost fully fairly valued by July, but since then, another divergence has occurred because of the sell-off.

Exhibit 3: Morningstar market fair value index

The technology sector, as illustrated below, was briefly overvalued from May through September, according to Morningstar, but the sell-off has once again made tech stocks relatively attractive.

Exhibit 4: Morningstar tech sector market fair value index

Although the tech sector may look attractive compared to just a few months ago, we should not forget the fact that many tech companies are already valued at rich multiples. The best-performing tech stocks, in particular, are either trading in line with their 5-year P/E averages or at a premium to their historical averages.

Source: Morningstar

Given that Big Tech companies are relatively expensively valued based on their historical valuation levels, I believe investors should look for opportunities in small-cap tech stocks that have mostly remained hidden from the market eye. One risk to this strategy - a major risk - is that these hidden gems may remain hidden in the foreseeable future, and investing in these companies may lead you to feel that you are missing out on gains if big tech companies continue to dominate the short-term market performance. As long-term-oriented investors, however, we should not let such short-lived underperformance dictate terms over our investment decision-making process given that small-cap tech stocks have the potential to substantially outperform the broad market - including big tech stocks - in the long term when invested at the right valuation.

Two Sectors I Like More Than Tech

Although I believe the Fed may end up being forced to keep interest rates at elevated levels for longer than Mr. Market initially thought, eventually, rates will come down. I do not have a crystal ball to predict with a degree of certainty when this would happen, but history will repeat, and interest rates will come down. I expect rates to cool down starting from mid-2024 following a few challenging quarters for the U.S. economy. When this happens, the beaten-down sectors of 2023 will benefit from a change in fortunes. Based on these expectations, I believe utilities stocks and real estate sector stocks will make a roaring comeback in 2024.

Exhibit 5: S&P 500 sector performance as of October 17

In the coming weeks, I will hunt for small-cap bargains in the utilities and real estate sectors. Stay tuned for a few in-depth research reports on several of these companies.

Takeaway

Wedbush Securities analyst Dan Ives is calling for a strong year-end to tech stocks. As an investor with substantial exposure to the tech sector, I would welcome such a development. As an analyst, however, I believe investors should focus more on the underperforming sectors of this year such as utilities and real estate as we move closer to 2024 - a year that is likely to see the reversal of the Fed's aggressive policy tightening.

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