Tech sector has 'a false sense of security' and is vulnerable, Morgan Stanley says


Tech stocks rose in pace with the broader market Monday, ahead of what’s expected to be a relatively strong earnings season, but Morgan Stanley is starting to see leaks in the sector’s gas tank.

Tech stocks on the S&P 500 index












SPX, +0.88%










rose 0.8% while the broader index finished up just shy of a 0.9% gain. Much of the drag on the tech sector came from shares of Twitter Inc.












TWTR, -5.38%










which fell 5.4% after a report of account suspensions. For the year, the S&P 500’s tech sector has gained nearly 14% while the broader index has advanced 4%.

Those days of strong performance are numbered, Morgan Stanley said in a note headed by equity strategist Michael Wilson. The analysts downgraded the tech sector to underweight from equal weight, Morgan Stanley’s second downgrade for the sector this year, amid a growing number of red flags for the sector.

“In our experience, rolling bear markets are not over until they have touched every last corner, with the highest quality areas often coming under pressure at the end,” the note said. “Given its exceptional growth and quality characteristics, Tech has been a holdout to date.”

“However, we suspect it will not be immune from the changing attitudes toward risk assets we are seeing across markets and think the sector may have benefited from a false sense of security the past few months,” Morgan Stanley noted. “When we hear things like Tech is no longer cyclical or Tech is a low vol/risk sector now, we cannot help but think its vulnerability has reached a concerning place.”

Read: Morgan Stanley downgraded another hot sector Monday

Already priced into tech valuations are an expected strong earnings season, the firm said. In the coming weeks, tech sector earnings are expected to grow by 25% over the year-ago period, with double-digit growth from subsectors such as internet software and services; semiconductor and semiconductor equipment; technology hardware, storage and peripherals; IT services; and software.

That growth has pushed price-to-earnings ratios for the next 12 months to levels that are well above the rest of the S&P 500.

“These are not bubble valuations like in the late 1990s, but we think it more likely we revert to the near term mean than move higher from here,” according to Morgan Stanley.

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Add to that the uncertainty created by U.S. tariffs and retaliatory tariffs and tech is not looking so attractive. Tariffs are a problem for tech as “perhaps no sector in the global economy has benefited as much from low trade barriers as Tech,” Morgan Stanley said, so expect outlooks to be very cautious from the tech sector this earnings season.



In what Morgan Stanley sees as a preview of the broader sector, the firm points to the chip sector’s recent performance, which dropped considerably in June, leading the chip sector to turn in its first quarterly decline in nearly three years. Chip stocks fell under pressure again just before the Fourth of July holiday after a Chinese court blocked sales of certain Micron Technology Inc.












MU, +2.03%










 chips, but most analysts played down the development.

In other tech indicators, the tech-heavy Nasdaq Composite Index












COMP, +0.88%










 has advanced 12% on the year, while the PHLX Semiconductor Index












SOX, +0.66%










 and its exchange-traded fund, the iShares PHLX Semiconductor ETF












SOXX, +0.64%










are up about 8.5%.

In other ETFs tracking the tech sector, the Technology Select Sector SPDR ETF












XLK, +0.76%










is up 12% for the year, while the SPDR S&P Semiconductor ETF












XSD, +0.71%










 is up 8%, the iShares North American Tech-Software ETF












IGV, +0.51%










 has surged 23%, the First Trust Dow Jones Internet ETF












FDN, +0.86%










 has rallied 31%, the First Trust Cloud Computing ETF












SKYY, +0.88%










has risen 20%, and the First Trust Nasdaq Cybersecurity ETF












CIBR, +0.33%










 has gained 17%. All those ETF finished 0.3% to 0.9% higher Monday.



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