Technology – should Investors swipe left or right?
Why we remain positive on the outlook for technology firms at Asset Intelligence.
Tech stocks have had a great run in 2020 as the Covid-19 crisis accelerated the spread of digital and online activity. After the historic stock market slump in March, the leading tech companies (that’s Facebook, Apple, Microsoft, Amazon, and Google/Alphabet, or the ‘FAMAGs) drove the fastest ever recovery1 from a bear market.
The fact that share prices in the sector have appeared to defy gravity of late can put investors on edge. Those of us with long memories will never forget how the dot-com bubble burst, causing the tech-heavy Nasdaq benchmark to slump around 78% between March 2000 and October 20022. And some warning lights are flashing. In August, Apple became the first US company to hit a $2 trillion stock market valuation3, just two years after passing the $1 trillion milestone. And tech companies now account for a higher proportion of the total market value of the S&P 500 since…1999. This gives the sector unprecedented influence over the overall equity market, regardless of which direction it is heading.
However, when you look at the fundamentals, there are reasons why the sector’s valuation premium might be justified and why it could continue to prosper.
Firstly, it’s important to note that the situation today is far removed from where things stood during the height of the dot-com bubble. Back then, a significant proportion of listed technology firms were hastily conceived start-ups with minimal profits and often even scanter business plans. Remember pets.com? Exactly.
Today’s tech companies frequently count among some of the most cash-rich companies on the market. Often these profits have come courtesy of dominant market positions, astute business plans and brands held in extremely high regard by consumers. Most of us haven’t searched the internet in years… we Google things. Aside from the tech titans, a deep bench of up-and-coming names, often operating in niche areas, are also experiencing considerable success.
But is this tech boom sustainable? As any investor would expect, one driver for considerable declines in share prices would be major falls in earnings. Yet there is little sign that this will occur anytime soon in the tech sector, with a number of these firms primed for a world that is increasingly moving online. Tech companies are having a disruptive impact in fields as diverse as retail, healthcare, transport, finance and the media. Almost every aspect of most people’s day-to-day lives has been changed technological innovations in the past twenty years or so. And with cloud computing, artificial intelligence, 5G, robotics, driverless transport, augmented reality and more all still in their infancy, there are plenty more advances to come.
Of course, none of that means we should throw investment fundamentals out of the window. In addition to the intrinsic product and competitive strength that firms such as Apple, Microsoft and Google owner Alphabet boast, they appear to have economic conditions and market dynamics on their side. Historically, periods of market exuberance and high valuations have often come to an end when central banks remove support from the economy (the Federal Reserve in particular). Given where the global economy stands today, the chances of this happening anytime soon are miniscule. In fact, central banks have been falling over themselves in recent months to ease policy further, expanding Quantitative Easing stimulus packages and moving ever closer to negative interest rates. Indeed, the Fed’s recent adjustment to its inflation-targeting approach4 – it will target an “average” of 2% inflation, rather than making 2% a fixed goal – implies that it will be able hold interest rates lower for longer to stimulate US growth and employment.
A world of ultra-low interest rates would also appear favourable for technology companies. With their relatively low earnings yields (the inverse of the P/E ratio) and promise of even greater future profits and dividends, growth stocks trading at higher valuations effectively count as ‘long duration’ assets, which perform well when interest rates are low. In a low-growth environment, companies with the ability to generate their own revenues and business expansion would appear to have the competitive edge.
And there’s another important dynamic to consider. With returns on cash and bonds so low, property facing long-term structural challenges and value stocks still struggling for the most part, it is unsurprising that many investors are looking at growth stocks – with the tech sector leading the charge – and wondering ‘what is the alternative’?
Are there any potential clouds on the horizon? US government policy after the elections could be one. Some in the Democratic Party have begun to express concern about the dominance of the top tech firms and could seek to pursue more restrictive regulation or even antitrust suits should they end up winning control of the US Senate in January. Still, with some notable exceptions, politicians are seldom so radical in government as they are in opposition, and with the election result so tight, the chances of significant action are relatively slim.
Another argument is that the economic damage wrought by the Covid-19 pandemic will restrict firms’ capacity to invest in improving their technological capabilities. While this may be true for the very worst-hit firms in the short term, most CEOs and company boards are acutely aware of how fast industries and consumer habits are changing, and recognise the need to future-proof their business model. As such, shrewd management teams will likely recognise the importance of investing in technology to remain competitive, even when under financial stress.
All in all, there seems to be much more going for technology stocks than there is against them. Arguably investors had the right idea back at the turn of the millennium – they just called it twenty years too early.
If you would like to discuss your financial situation, please speak to your financial adviser in the first instance.
Past performance is not indicative of future results.