For a sector accustomed to getting headlines for its stellar growth and equity returns, the past few weeks have felt a bit different for technology companies. It's time to take stock, think about what we’ve learnt and revisit our bullish macro case for the sector. In short, however, I still like tech.
While Alphabet, Apple and Amazon all delivered another set of expectation-beating quarterly results, Facebook crashed the party for the second time this year. As bad as the market’s reaction was, it’s important to keep two key things in mind when interpreting the information contained in Facebook’s results.
Firstly, the sell-off in the company's shares came after a big rally and sharply raised investor expectations. Even the 19% correction on the day still left Facebook shares trading almost 20% above the lows seen during the Cambridge Analytica scandal. Secondly, the disappointment is largely down to company-specific issues. Facebook’s reduced revenue growth guidance seems predominately due to a business decision to shift focus to a part of the business that is (so far) less well monetised. We believe this offers limited read-across to the rest of the sector.
Positioning isn't as bullish as it seems
The market reaction to the tech results over the past couple of weeks appears to have revealed that investor positioning is only moderately bullish towards the sector. Yet it feels like week after week, investor surveys tell us that tech is the largest 'consensus long position' in the market.
However, one of the criticisms of using investor surveys as an indication of positioning could apply here. Sometimes surveys can be more a reflection of how investors wish they were positioned, than how they are actually positioned. You would expect a sector with super bullish sentiment and positioning to be over-sensitive to even small bits of bad news.
Yes, tech has underperformed over the past week, but given the preceding outperformance, the reaction so far remains relatively muted and not (yet?) on par with the corrections of recent years. Interestingly, the effect upon the rest of the tech sector was very limited on the days that Netflix and Facebook (two high profile FAANG stocks) disappointed markets; most of the underperformance occurred on subsequent days.
However, the market reaction to Facebook’s results has been a useful reminder that the sector is not invincible. Some of the biggest tech bulls argue the sector is a ‘buy’; even during the next recession. I disagree. Tech business models may not be the most cyclical in the market and some companies may even take market share from traditional competition in a recession, but Facebook’s experience showed how sensitive share prices are to question marks over the growth trajectory. In a recession and the accompanying bear market, investors will be less willing to attribute value to the uncertain growth potential in the distant future.
Taking a quick look at our original macro buy case for tech, we believe the arguments remain valid today. Though not part of our base case, a retail-driven equity bubble remains a possibility and we see tech as a prime potential beneficiary of an equity 'melt-up' scenario towards the end of a market cycle. The US economy continues its progress towards 'late-cycle', where tech’s low labour cost exposure, high margins and high cash balance should be supportive factors.
Taking a quick look at our original macro buy case for tech, we believe the arguments remain valid today
With tech's outperformance of the broader US market over the past couple of years roughly matching relative earnings, the valuation premium of tech remains a manageable 8% on a PE basis. The continued earnings growth from the sector as a whole, exemplified by strong numbers from Alphabet, Apple and Amazon, makes this premium look attractive in our view. Our greatest concern remains a regulatory ‘techlash’, but following Cambridge Analytica there seems to have been little escalation in this risk.
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