Software stocks could support the tech rebound

Jhe first half of 2022 has not been good for equities, and tech stocks have been among the most egregious offenders. Obviously, this is a drag because technology is the largest sector exposure in a variety of broad market strategies.

Exchange-traded funds such as Invesco QQQ Trust (QQQ) and the Invesco NASDAQ 100 ETF (QQQM) are not dedicated tech offerings, but they are more than enough industry proxies. Allocating around half of their weighting to tech stocks, QQQ and QQQM are clearly sensitive to events in the tech sector.

If the worst is behind the bunch, and it’s set to improve in the second half of 2022, Invesco ETFs could leave the disappointment of the first half in the rearview mirror. Fortunately, valuation is no longer a barrier to entry with tech stocks and ETFs.

“While macroeconomic concerns are at the forefront of investor concerns, we still see strong underlying secular tailwinds in technology, such as cloud computing and semiconductor adoption. Technology is now 20% undervalued and 21% undervalued in software, where we often see companies moated,” noted Morningstar analyst Brian Colello.

This is potentially good news for QQQ and QQQM, as the Nasdaq-100 Index (NDX), which is the underlying index for both ETFs, is packed with semiconductor and software stocks. About 15 of the technology stocks in ETFs are chip names. The funds’ large exposure to software is also relevant from a valuation perspective.

“Software remains the most attractive sub-sector, undervalued by 20%. The high-flying growth stocks of 2020 have crashed, and many are now trading well below our fair value estimates. Meanwhile, more mature and higher-quality software names now offer investors a nice margin of safety,” Colello added.

Previously among the hottest tech names, cloud computing stocks have come down to earth in a big way. However, this does not change the need for extensive cloud services, and this pullback makes valuations more attractive. This could be a catalyst for QQQ and QQQM as ETFs are home to multiple cloud names.

“In software, IT departments have been focused on digital transformation, first since the centuries-old shift to cloud computing and software as a service, followed by the coronavirus pandemic and the critical rush to implement remote working tools. We predict that companies will use software to modernize all types of business processes, which in turn will drive the software industry to grow at a double-digit CAGR,” Morningstar’s Colello concluded.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

About Dianne Stinson

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