China Securities Co., Ltd.: Has the bottom of US technology stocks been reached?

China Securities Co., Ltd. released a research report stating that a key feature of the recent decline in US stocks is that technology stocks are leading the correction. After reaching a historical high of 7000 points at the end of January this year, the S&P 500 began to decline, while the Nasdaq index began to peak and fall earlier, reaching a low of 20690 points after peaking at 24000 points at the end of October last year, with a maximum decline of nearly 14%. After this round of adjustment, with valuation compression and profit upgrades, US technology stocks are likely bottoming out, making it a buying opportunity. In the base case scenario, even if valuations cannot expand under AI concerns, profit improvement can still provide upside potential. In the optimistic scenario, a "double-click" is likely. In the pessimistic scenario, a second bottoming caused by tensions between the US and Iran, technology still offers relative returns. The main points from China Securities Co., Ltd. are as follows: Event: After a significant retreat in the technology sector of US stocks from historical highs, some signs of stabilization have appeared, coupled with the US-Iran negotiations beginning, is now a good time to re-enter technology stocks? Key points: A key feature of the recent decline in US stocks is that technology stocks are leading the correction. The S&P 500 started to decline after reaching a historical high of 7000 points at the end of January this year, while the Nasdaq index, which peaked at around 24000 points at the end of October last year, started to fall earlier, reaching a low of 20690 points, with a maximum decline of nearly 14%. Despite facing many short-term issues, technology stocks are still not easy to bear in the mid to long term. So, is the current US technology stock at a buying point? The institution believes that since the adjustment, US technology stocks are likely in the bottom range and can be bought on dips: Firstly, the valuation pressure of US technology stocks has been significantly released, with profit upgrades, supporting strong fundamentals; Secondly, in the base case scenario, even if valuations cannot expand further under various AI concerns, profit improvement can still provide upside potential; Thirdly, in the optimistic scenario, the possibility of a "double-click" cannot be ruled out; Fourthly, in the pessimistic scenario, if macroeconomic impact leads to a second bottoming, technology stocks still offer relative returns, providing a certain degree of risk aversion. Focus on the following logic: (1) Significant compression in technology stock valuation, the lowest in nearly six years; and the premium rate relative to the overall market approaching zero, the lowest since 2017 The valuation of the S&P 500 information technology sector has dropped from a peak of around 30.5 times to a low of 19 times, basically returning to pre-epidemic levels. More importantly, the valuation premium of the technology sector relative to the US stock market has dropped to around 5%, the lowest since 2017. If the market continues to recover, the premium rate of the technology sector may rebound. (2) Internally in technology stocks, the compression of valuations is widespread, not driven by a single sector such as software stocks The progress of AI in the past has had a significant impact on the valuation of software companies. However, data shows that since the second half of last year, the software industry has seen the largest compression in valuations at 40%, while the overall technology sector is at 36%, with no significant difference. This means that valuation recovery is widespread in many sub-sectors of technology (overall safe) and not solely driven by software stocks. (3) Strong earnings expectations in technology stocks, continuously upgraded since the beginning of the year, with a clear relative advantage; reflecting concerns about AI risk mainly at the valuation level Since the beginning of the year, earnings expectations for the technology sector have been raised by more than 10%, while sectors such as consumer goods, real estate, and industry have seen significant downward revisions. Currently, the 10-year percentile of earnings for the technology sector is below 50%, only higher than the real estate sector, while profit growth is far ahead of other sectors. After the disappearance of the premium valuation, the stability of its earnings superiority is once again highlighted, with a high cost-performance ratio. The stability of earnings expectations also indirectly reflects that the recent adjustment in technology stocks is mainly to digest valuations, with doubts about AI capital expenditures and market concerns about short-term operations. (4) The negative sentiment of AI narratives has diminished, and since the tensions between the US and Iran, technology stocks have played a hedge role and gained favor once again The negative narrative of AI has been reinforced continuously since the fourth quarter of last year, with the Nasdaq index continuously underperforming the market, indicating market doubts about it. However, after the deterioration of the Middle East situation, the market sentiment has once again turned in favor of technology, showing marginal improvement. (5) Overall, the downside risk of US stocks is manageable, providing support for technology: first, holding the key level of a 10% retracement; second, releasing the pressure of excessive gains in cyclical sectors In addition to the pressure of AI doubts, US stocks faced two other risks in the first quarter: systemic geopolitical risks and structural risks of recovery trades being falsified. For now, both are relatively safe, with overall US stocks not falling significantly, and the recovery in technology can provide support. Firstly, after the US-Iran conflict, the S&P 500's maximum retracement from its historical high is around 10%, and the Nasdaq is around 15%, similar to the routine 10% retracement that occurs once a year in US stocks, without showing a serious systemic risk tendency. In contrast, events such as the tariff impact last year and the interest rate hike in 2022 led to retracements of over 20% in the S&P 500 (usually once every three years), as long as conflicts do not worsen significantly, the S&P 500 may only retest the 10% retracement line (a second bottom), but with bottom support. Secondly, from the end of last year to the beginning of this year, the recovery trade became the mainstream narrative, driven by the improvement in profit expectations in cyclical sectors. China Securities Co., Ltd. had previously been concerned that the foundation of the US economy is not solid, and once the recovery is falsified, related sectors would face adjustment risks. Currently, the US-Iran conflict has helped puncture these expectations. In the first quarter, the profit expectations for industrial, consumer, and real estate sectors were significantly downgraded, relieving pressure. (6) Expectations of interest rate cuts in the second half of the year will provide macro support for technology stocks Maintaining an optimistic attitude towards interest rate cuts for the whole year, a general decline in interest rates will be favorable for the technology narrative. Risk Warning: US inflation exceeds expectations, US economic growth exceeds expectations, leading to continued tightening of US Federal Reserve monetary policy, a significant appreciation of the US dollar, a rise in US bond yields, continued decline in US stocks, banking crises, and emerging market currency and debt crises. US economic recession exceeds expectations, leading to liquidity crises in financial markets, forcing the Fed to adopt loose policies. The European energy crisis exceeds expectations, the Eurozone falls into a deep recession, global markets enter turmoil, external demand shrinks, policy faces a dilemma. Global geopolitical risks intensify, US-China relations deteriorate beyond expectations, uncontrollable factors in commodity and shipping markets, increasing degree of deglobalization, continuous disruption of supply chains, worsening resource competition.