US tech stocks continue to lead the global market upswing. The boom shows no sign of ending.
Even a stopped clock is right twice a day. Technology bears, however, have been waiting ten years for vindication, their tidings of gloom getting ever louder. Even in this year’s tricky markets, the sector has surged ahead, with Apple becoming the first company to pass $1trn of market value. Amazon, up 100% in a year, has also reached this milestone.
Will this all end in tears? Perhaps one day, but the specialist managers in the sector see no sign of it yet. Moreover, without a crunch in the technology sector, it is very hard to see a bear market in US equities overall.
As James Ferguson of MacroStrategy points out, “strip out the tech sector plus Amazon and the prospective price/earnings ratio for the rest of the S&P 500 index falls to just 14.4 times, only a little higher than that for the struggling emerging-markets index”. Similarly, the MSCI World index, 55% of which is accounted for by the US, is hardly likely to perform poorly without the US suffering.
Tech stock valuations are still reasonable
US strategist Ed Yardeni shows that technology’s share of the S&P 500 index has risen from barely 5% in the early 1990s to 26%, even though the sector officially excludes tech-enabled companies such as Amazon, Netflix and Tesla. Its share of the S&P’s earnings has risen to 23%. The market value of the US tech sector is more than the combined market cap of the UK and Japanese markets.
“This growth,” says Walter Price, the manager of the £500m Allianz Technology Trust (LSE: ATT), “is coming from the creation of new markets… Other sectors, such as automobiles, advertising and retailing, are being shaped and transformed by advances in technology, creating great value for investors.”
Ben Rogoff, manager of the £1.9bn Polar Capital Technology Trust (LSE: PCT), notes that the US tech sector’s current multiple of forward earnings is barely above the 25-year average of 18.7 and its premium to the overall market is lower than average. “The sector has delivered on earnings,” he says. There has been no help from leverage – “most companies have net cash while the rest of the S&P 500 has net debt” – and none from raising prices, with the cost of computing and storage having collapsed in the last 25 years.
This has paved the way for “digital disruption”, enabling start-ups to take on the giants, who were previously protected by their control of physical distribution channels. “There has never been a better time to be a small entrepreneur,” says Rogoff, “provided… they do not try and compete with… Google (two trillion annual searches), Facebook (2.2 billion customers), Amazon (44% of US e-commerce from 562 million products), Uber (five billion rides), Booking.com (1.3 million properties online) and Airbnb (five million listings).”
Which of the two trusts to choose? ATT has produced an investment return of 230% over five years, 12% ahead of PCT, thanks to a one-year return of 40%, 9% more than PCT. Both trusts are comfortably ahead of the technology sector, which is up 198% over five years and 24% over one. The shareholder return of ATT has been higher still, thanks to a discount to net asset value turning to a premium, while PCT has consistently traded at a premium. Neither trust pays a dividend.
While PCT has 70% of its portfolio in US companies, ATT has 84%. Both managers are cautious in the short term, with ATT having nearly 8% of cash and PCT almost 7%. The money is earmarked for topping up the software sub-sector on bad days in the market, says Rogoff. PCT has a bigger bias towards large caps, with 77% of the portfolio in firms with market values above $10bn (12% below the sector index); ATT has only 63%.
Keep an eye on regulators
Although PCT has no exposure to companies such as IBM, Oracle and SAP, it sticks closer to the index than ATT. Around 3% of the portfolio is in non-index Amazon, compared with 7% for ATT. ATT has 1% in each of Netflix and Tesla, though Price had nearly 10% of the portfolio in Tesla a few years ago. Elon Musk’s behaviour is erratic but, as one West Coast savant puts it, “everybody sneers at Tesla until they get to sit behind the steering wheel”.
Rogoff accepts that his portfolio is considerably more expensive than the index, but says that it is “10%-30% more expensive for 40%-50% more growth”. With earnings growth fully supported by revenue growth, valuations are far from the sky-high levels reached at the turn of the millennium. “Our concerns are regulation, not valuation.”
Common criticisms of tech firms are valid. For example, companies have exploited tax loopholes to the full. Peter Bazalgette, chairman of ITV, has argued that social media’s avoidance of the supervision imposed on the rest of the media, on the grounds that it is the customers of companies such as Facebook who are the publishers rather than the companies, is hard to defend. Still, there is clearly a great deal of sour grapes from the political establishment, notably in the EU, about America’s dominance of the sector.
This has driven the 220% outperformance of the US market over the rest of the world in the last ten years and it will only be enhanced by any protectionist measures imposed to try and hobble it. America isn’t going to kowtow to the sector’s critics; after all, it is technology, not Trump, that is making America great again. It’s too soon for investors to steer clear.