Why tech stocks may remain under pressure

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The operating environment for the tech sector is getting tougher, even though the sector’s shares aren’t particularly overpriced, Capital Economics said in a note on Thursday.

It pointed to two factors that are darkening the earnings outlook for IT firms: First, the possibility of tougher regulation, particularly over how the sector handles customer data, and the second is the risk of protectionism.

“Clearly, if regulatory scrutiny or protectionism are ratcheted up further, then there is a good chance that the IT sector will continue to fare particularly badly,” it said. Capital Economics previously said that fears that the Trump presidency would be punctuated by protectionist announcements and possibly actual action would weigh on sentiment.

“Those focused on software would probably have most to lose from stricter data privacy regulation. Indeed, the IT firms in the GICS software and software services industry group have performed worst since the revelations about the alleged misuse of data in election campaigns a couple of weeks ago,” Capital Economics said. “Meanwhile, those focused instead on producing hardware that rely on global supply chains appear at greater risk from trade tensions.”

That’s even as Capital Economics estimated that the valuations of IT firms’ equities aren’t particularly stretched.

“The price/forward earnings ratios of IT firms in most of the world are currently only a little above those of broader equity indices. The only notable exception is the MSCI China Index,” it said.

But it added, “even if the price that investors are paying for their earnings is not excessive, share prices may remain under pressure as earnings themselves are squeezed. We think that they are also particularly vulnerable to a cyclical slowdown in the U.S. economy next year.”