Before the coronavirus crisis hit, big tech stocks – the FAANGs plus their various compatriots – were by far the leaders of the pack when it came to investments. And now? Well, they’re still the leaders.
As Robin Wigglesworth points out in the FT, the tech-heavy Nasdaq index has rallied from March and is now in positive territory for the year. What on earth is going on?
This rally has been mostly about the tech stocks
The S&P 500 has rallied strongly from its late-March low. However, this has been led by a very narrow group of tech companies.
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Wigglesworth points to some interesting stats from David Kostin of Goldman Sachs. The median average stock in the S&P 500 remains about 28% below its high. Meanwhile, the five biggest S&P 500 companies – all tech stocks – "now account for a fifth of the entire index’s market capitalisation”. That’s a modern-day record.
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Historically, this level of dominance by a small group of companies is an indicator of overvaluation. Of course, you’ve been able to argue that the US market has been overvalued on most – perhaps all – widely-accepted measures for a very long time now.
And at the same time, it’s hard to say that this is entirely irrational. Which companies have benefited from the coronavirus outbreak, or at least been most resilient? You’d have to argue that, as a sector, it’s the tech companies.
Regardless of whether you believe that predictions of coronavirus creating a “new normal” are massively overblown or not, it’s clear that the digital world has gained at the expense of the physical world, for want of better terms.
The lockdown has accelerated changes in our behaviour that were probably coming anyway, but might have been a long way off. People in many industries will work from home more and use video conferencing more.
That in turn means less demand for office space, less business travel, and less need for cafes and corner shops servicing the lunchtime and snack-break rushes.
So some businesses will see a lasting boost to demand – those that provide or facilitate online services. Some will see permanent demand destruction – anyone linked to business travel, from long-distance meetings to the daily commute (hence Warren Buffett selling his airline holdings).
Others will see demand transformation and disruption – we all eat roughly as many calories as we did before, but we get more of it from supermarkets than from restaurants.
That may not become permanent – I can’t imagine that people will really want to eat out less – but I can see the mix changing significantly. And lots of restaurants simply won’t be able to survive given the length of time it will take for lockdown and social distancing to end.
So you can see why the tech companies have been the biggest beneficiaries of the rebound. They may well seem like the safest options in a very uncertain world.
What happens when inflation comes back?
Nevertheless, I do think there’s a catch here. In my view, the continued dominance of tech stocks (and the extravagantly low yields on bonds) points to the one thing that the coronavirus outbreak hasn’t really changed much, and that’s the financial backdrop.
We are still in a bull market for “long duration” assets, or what I’ve sometimes called the “jam tomorrow” bull market. Or what you could also call the “long illiquidity” market.
Long story short, if you keep interest rates suppressed then the old proverb “a bird in the hand is worth two in the bush” doesn’t really hold anymore. The value of getting paid today relative to getting paid tomorrow is negligible. In some cases, it might even be negative.
This is good news for “growth” stocks (ie, tech and the like) because the future payoff is so much greater than the need for current profits or payouts. By contrast, the “value” stocks which provide those current profits and payouts are also deemed to be in secular decline (and in some cases probably are).
Of course, sometimes you need to get paid today because you don’t have any money and you have bills coming due. But if, as well as suppressing interest rates, central banks dive in and provide liquidity at the drop of a hat, then it makes little sense to sit on any cash or easily realisable assets at all except where you’re legally required to.
What has the central bank response to Covid-19 been? To suppress rates even harder, and provide as much liquidity as requested. So it makes sense that the stocks which were doing well pre-crisis are still the best performers now.
What changes that? Unless and until inflation starts to pick up – effectively increasing the value of that bird in the hand again – then this underlying trend is likely to continue. That’s one reason why I’m glad that the MoneyWeek model investment trust portfolio contains the tech-heavy Scottish Mortgage Trust, for example.
Of course, we think that the reaction to the coronavirus is indeed likely to result in inflation finally picking up. Which is why I’d suggest you take a look at how your portfolio is currently positioned, and have at least some of your assets in gold.
We’ll have much more on gold (and why it’s generally deemed a good defence against inflation, among other things) in the next issue of MoneyWeek magazine, out on Friday. If you haven’t already subscribed, I’d jump in now – you get your first six issues free, plus a free ebook on market crashes from history.
