At the point of writing, the NZX 50 [NZX:NZ50] is down about 7.5% off its 1 October high.

Yahoo Finance

Source: Yahoo Finance

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It’s following a plunge that originated on the American markets…with the S&P 500 having nearly erased all the gains it’s made this year.

The worst of it hit stocks in the energy, insurance, and tech sectors.

Energy makes sense. Oil prices are down about US$5 from their September high of US$76 per barrel. That could be enough to spook some investors.

Insurance — and its cousin, the financial sector — are feeling the hit as Hurricane Michael ploughs through the American eastern seaboard. Nothing like a tsunami of claims to spark a sell-off.

And tech. Well, tech is a different story than energy or insurance. These sectors have temporary situations that are triggering a temporary reaction.

Tech, on the other hand, has been relatively quiet. So why the targeted sell-off?

I believe it’s because they have the most fat to trim.

  • Facebook — down 14% this year.
  • Alphabet and Apple — both down 4.6% yesterday alone.
  • Netflix and Twitter — off by more than 8% each this week.
  • Chipmakers AMD and Nvidia — fell about 8%.

According to the Financial Times, yesterday was the worst day for largest tech stocks on the NASDAQ since 2011.

And yet, most of those companies are still selling at ridiculous price-to-earnings ratios.

  • Netflix at 146x.
  • Amazon at 136x.
  • Twitter at 87x.
  • Alphabet at 47x.

For reference, most other industries average around 20 times price-to-earnings.

Some have proclaimed that this is the new normal for the tech sector…but I tend to disagree. The same way I disagree with how many believe New Zealand’s housing prices are the new normal.

No way, José.

A super-high P/E ratio — like a super-high median house-price-to-income ratio — is a red flag. It should make you as an investor a bit worried.

And these stocks — the mystical FAANG companies — have been soaring at extraordinary heights for the past few years…

We predicted that Facebook would tumble back in July. Today investors proved us right.

Our network of contributors backed us up.

Two months ago, Bill Bonner said, ‘The FAANGs Will Crash.’

Harje Ronngard predicted, ‘It’s entirely possible you’ll see huge share price declines for the high flying FAANGs and BATs. Periods of little to no price movement are just as likely, maybe more likely than a huge drop.

Even our tech perma-bull, Sam Volkering, knew this was coming. Ten weeks ago, he stated, ‘It seems as though the FAANGs have lost their teeth.

So, after weeks of saying it’ll rain, it finally has.

Don’t get me wrong — we’re not happy about it. We hate downturns as much as any investor. But we knew this was coming…and it’s reassuring to see that our analysis had basis. [openx slug=inpost]

So where is it going from here?

Pie Funds research head, Mark Devcich, believes this is the start of a correction. He told National Business Review (emphasis mine):

It’s healthy turbulence. The market had overshot in the upside, especially in the tech sector. It’s been straight up in the US since February and we normally see a couple of corrections a year, and this seems to be the start of one. There’s opportunity if there’s volatility and you’ve got higher cash levels — it’s bargain territory. We like volatility.’

The head of research for Fat Prophets, Greg Smith, believes there could be more rocky days ahead:

It had a strong start, a correction in February and has been running smoothly since. October and November will potentially be trickier.

We’ll have to see how the global reporting season goes, and the impact of trade frictions.

At the same time, Shane Solly of Harbour Asset Management told the NZ Herald:

‘”We are going to see another day of softness in New Zealand,” he predicted.

But Solly said he didn’t believe it would be as bad as yesterday’s drop which hovered around 2.5 per cent before dropping another 1 per cent in the last hour of trading.’

So which is it? A full correction? A turbulent season? Or simply a couple days of negative pressure?

Here at Money Morning New Zealand, we’re quick to admit we don’t know.

The talking heads seem to be pretty confident. Some even put out specific timelines and percentages.

I’d love to know where they got their economic Magic 8 Ball.

All we know is that the market is generally overpriced…and that, historically, markets tend to revert to the mean rate of growth.

But we’re not even thinking about day-to-day movements. 4% up today. 6% down tomorrow. 8% up the day after that. Who cares? That’s for the day traders to gamble on…

We’re looking at longer time frames — months, years, decades. We want to see how these mountains and valleys average out over time…and what that means for investors at big-picture level.

Right now, our best guess is that markets — particularly New Zealand’s market — have a whole lot more fat to trim before they can be diagnosed as healthy.

Especially the tech sector. That giant needs to hit the gym and lose a good majority of his belly fat before he’s back in the normal range.

But this is all coming from a rational, numbers-based perspective…

Consumers can be irrational…and can demonstrate, as Alan Greenspan coined it, ‘irrational exuberance.’ And any time we see big swings in short windows, we know that emotions are involved…

So we’ll have to wait and see just how rational this market decides to be…

Taylor Kee
Editor, Money Morning New Zealand