Investing in technology in 2020
Even with the huge disruption caused to economies and markets by the COVID-19 pandemic, on the face of things 2020 may not be a bad year for equity investors. After all, the US market, as measured by the S&P 500 Index, is up by 4.5% at the time of writing*. Pretty good, given the precipitous falls seen between late February and late March. At its nadir this index was down 31% from the end of 2019 and has now recovered by fully 51%.
But most, if not all, of this performance has been focused on a select group of sectors, some of which were already enjoying very strong momentum even before the pandemic struck. These sectors have been seen as big beneficiaries of the changes wrought by COVID-19, such as working and shopping from home, as well as the accelerated adoption of new technologies such as cloud computing, artificial intelligence and increased cyber security.
The lop-sidedness of the market is illustrated by using the technology-rich NASDAQ Composite Index as a proxy for technology as a whole; this index is up 25% over the year and has made more than 40 new all-time highs over 2020. Since technology now makes up about 30% of the wider US index, this great performance has in fact been responsible for more than the entire rise in the broad market.
Market leaders: Apple and Amazon continue to dominate
There have been some amazing moves. Amazon was up 90% in 2020 at the time of writing*; Apple by 80% and Microsoft by 48%. And it’s not as if the sector had a bad 2019. These three names have risen by 135%, 126% and 227% respectively since the end of 2018. When we wrote about technology in the previous issue of News & Views, we highlighted that just three US companies were worth more than the entire UK market. Now it is just two – Apple and Amazon. Apple on its own is now worth more than the entire FTSE 100 Index of top UK-listed companies.
The massive outperformance of the sector has prompted some to ask whether we are seeing a repeat of the so-called TMT (technology, media and telecoms) bubble of 1999 and early 2000. The market value of Tesla is now around twice that of oil major Royal Dutch Shell, even though its revenues last year were one fourteenth the size. Zoom (market value around US$120bn and up by 520% this year alone) has forecast revenues for 2020 less than one tenth those of AstraZeneca (market value around US$140bn and up a mere 12% year-to-date).
Is this another technology bubble?
These kinds of numbers do prompt some cause for concern. At first sight, a number of warning signals are beginning to flash at least amber for those of us who can remember what the 2000 tech bubble felt like.
Several companies have share price charts that look parabolic, and such performance is very difficult to sustain. This can lead to volatility and is rarely a good time to buy stock.
Just as in 2000, there is vastly increased and sometimes unhealthy retail investor interest in the sector, which can mean that investments are made less on rational grounds and more on sentiment. The growth in passive investing (where passive funds slavishly track the performance of a particular market or index, such as the FTSE 100) has meant very large, momentum-driven flows into the technology sector, flows that are not necessarily driven by fundamental analysis.
There have also been a number of single-day movements that are characteristic of bubbles in today’s market, just as there were then. For example, back in 2000 the shares in France Telecom (now called Orange and the French equivalent of British Telecom), having risen by around 250% over the previous two years, rose by 16% between 2 February and 4 February. In one astonishing session, they then rose by 26% on 3 March. Why? Because the company announced better than expected, but hardly transformational, results. It closed that day at €215.5 per share, a level it has never regained since. Today it stands at just under €10 per share.
Similarly, in early September this year, the share price of Zoom rose by 35% in a single day, after an even more stellar prior performance, on better than expected results, as more and more of us used the app in lockdown. This is not to say we now forecast a collapse in Zoom’s share price – it is very possible that the future of video-conferencing is much more robust than that of an early 2000s national telecommunications monopoly. But it is a potential red flag because it shows evidence of emotional, rather than rational investing.
2000 vs 2020: what differences are we seeing in the markets?
However, the good news is that despite some similarities, there are even more significant differences between 2000 and today.
Firstly, although valuations have risen over the last couple of years, they are nothing like the levels seen in 2000. In the TMT bubble back then, traditional yardsticks were abandoned, massive price to sales multiples became the norm and speculation was rampant.
Secondly, interest rates today are almost at zero (and below in some countries), whereas in 2000 the US Federal Reserve had raised rates to 6.5%. Low interest rates sustain high valuations because they increase the value of future cashflows and dividends. Moreover, given the challenges of economic recovery from the pandemic, it is most likely that rates will stay low for a very prolonged period indeed. We don’t think this support to valuations is going away any time soon.
Thirdly, the underlying businesses of technology companies today are huge compared with what they were in 2000. Many internet-based businesses then were based on future ideas that have since come to fruition. For example, from 2000 to the end of 2019, Amazon grew revenues 100-fold from US$2.76bn to US$280.5bn. Companies such as Apple, Google, Facebook and Microsoft generate vast amounts of cash today, whilst in 2000 many technology companies were generating losses as they tried to ramp up their business models.
Next, although the spread of the internet was opening up new pathways to growth in 2000, growth prospects for the technology sector today have rarely been brighter. Among other factors, these prospects are led by quantum computing, artificial intelligence, the explosion in cloud computing, remote working and living and the rapid development of countries such as China and India.
Finally, as noted earlier, the impact of COVID-19 has been to accelerate the roll-out of these themes, in some cases meaning that the effect of years of growth has been accelerated into the last few months.
Technology market: future threats and opportunities
Although there are some warning signals in technology markets today, we remain comfortable to have technology as one of our core investment themes. We may see some rotation out of the sector, perhaps as a COVID-19 vaccine is launched. However, thanks to the long-term secular drivers of growth allied to the massive strength and financial resilience of the sector’s major players, we would see any such pull-back more as an opportunity than as a threat.
*This article was originally written in mid-September 2020.
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Investment involves risk. The value of investments and the income from them can go down as well as up and you may not get back the amount originally invested. The information provided is not to be treated as specific advice. It has no regard for the specific investment objectives, financial situation or needs of any specific person or entity.
This is not a recommendation to invest or disinvest in any of the themes, sectors or companies mentioned. They are included for illustrative purposes only.
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IMPORTANT: Investment involves risk. The value of investments and the income from them can go down as well as up and you may not get back the amount originally invested. Past performance is not a reliable indicator of future performance.