What’s driving the dramatic drop in ASX 200 tech shares?

ASX 200 tech shares have experienced a dramatic sell-off, with the S&P/ASX 200 Information Technology Index (ASX: XIJ) now 22% lower than its September peak.

The ASX 200 tech stock index hit a record 3,060.7 points on 19 September.

Today, it’s 2,387.1 points, down 22% in just 10 weeks.

By comparison, the S&P/ASX 200 Index (ASX: XJO) has fallen 1.7% over the same timeframe.

All 11 market sectors have fallen from their historical high points set this year, but technology is the worst performer of the bunch.

Wilsons Advisory equity strategist Greg Burke says domestic factors are mostly to blame for the dramatic fall in ASX 200 tech shares.

Burke says the tech sector has been oversold and opportunities abound.

What’s dragging ASX 200 tech shares down?

In an article, Burke discussed the domestic factors weighing ASX 200 tech shares down.

Firstly, he points to an unwinding in sector momentum, commenting:

… tech sector valuations had become demanding, peaking at ~100x forward earnings in August.

With tech stocks effectively ‘priced to perfection’, even modestly underwhelming updates from WiseTech Global Ltd (ASX: WTC), TechnologyOne Ltd (ASX: TNE) and Xero Ltd (ASX: XRO) have been enough to trigger a sharp rotation out of the sector, likely amplified by quant-flows.

On Friday, the WiseTech share price is $73.60, up 5.6% today and down 23.8% since the tech sector’s peak on 19 September.

The Xero share price is $123.29, up 0.1% today and down 24.2% since 19 September.

TechnologyOne shares are $30.41, up 1% today and down 20.7% since 19 September.

Secondly, Burke says a sell-off in Australian bonds has also weighed on ASX 200 tech shares.

… domestic government bond yields have risen ~40 bps since mid-October, and the AU–US 10-year spread has widened, driven by hotter-than-expected Australian CPI and solid labour market data.

This has weighed on the valuations of interest-rate-sensitive growth stocks on the ASX, particularly within the tech sector.

Another factor is significant mergers and acquisitions (M&A) activity by the tech sector’s two largest companies.

Xero completed its US$2.5bn purchase of Melio, while WiseTech closed its largest-ever acquisition – the US$2.1bn purchase of e2open.

Both deals have clear strategic merit, but carry integration risks, while they also face an ASX investor base that is generally sceptical of large offshore M&A.

In Xero’s case, the sizable capital raise appears to have contributed to material stock indigestion, with seemingly few incremental buyers for the stock post the raise.

The final domestic factor is investors’ concerns over governance at Wisetech.

… after a year of scrutiny, WiseTech faces an AFP–ASIC insider-trading investigation over blackout-period share sales by founder Richard White and other senior executives, with multiple former directors now being questioned.

The ongoing uncertainty has created a material overhang on the company’s share price, weighing on the broader sector.

Should you buy tech stocks?

Burke says the pullback in ASX 200 tech shares “appears to have created attractive buying opportunities”.

While past performance is not a reliable predictor of future returns, drawdowns of more than 10% have historically presented attractive buying opportunities in the tech sector for patient capital willing to look through near-term volatility. 

This has been particularly true when underlying company fundamentals remain solid and macro conditions – particularly long-term bond yields – are relatively stable.

Both conditions largely hold today: the ASX 200 IT sector still offers a three-year forward EPS CAGR of 24% (well above the 8% offered by the broader ASX 200), while a consensus ‘on-hold’ RBA view – alongside our expectation of range-bound to lower bond yields – suggests tech valuations are unlikely to face additional material macro headwinds.

Wilsons Advisory’s preferred large-cap ASX 200 tech shares are TechnologyOne and Xero. 

The post What’s driving the dramatic drop in ASX 200 tech shares? appeared first on The Motley Fool Australia.

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Motley Fool contributor Bronwyn Allen has no position in any of the stocks mentioned. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has positions in and has recommended Technology One, WiseTech Global, and Xero. The Motley Fool Australia has positions in and has recommended WiseTech Global and Xero. The Motley Fool Australia has recommended Technology One. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.