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Analyzing the Tech Sector’s Valuations in May

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May. 28 2019, Published 12:13 p.m. ET

Markets have been wobbling in May

After a spectacular start to the year, stock markets have hit a bump in May due to an unexpected escalation in the trade war between the US and China. The Nasdaq Composite Index has fallen 6.5% since May 3 when the trade war took a turn for the worse. At that point, the index had risen 25% year-to-date.

The Nasdaq Composite Index is trading at 25.2x the trailing 12-month earnings, which is slightly expensive considering the higher premium the tech sector has been trading at in recent years. The tech sector’s valuations increased in the first four months this year due to easier financial conditions. The Fed said that it won’t raise rates this year. The earnings haven’t been good enough to warrant such a surge.

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Notable risks

The valuations appear expensive considering soft global economic expectations for the next few years. All of the FAANG stocks are seeing a notable slowdown in their revenue growth, as the above graph shows.

The trade war is the biggest near-term risk for tech stocks. Tariffs would squeeze the margins of tech companies with exposure to China. The macro perspective could even cause inflation to rise.

Another risk to the markets is that the dollar has been steadily heading higher this year. A stronger dollar is a headwind for companies that have international exposure.

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