The tech sector served investors well in 2020 and 2021 during lockdowns, as people stayed home to work and shop and enjoy more online entertainment, says Fidelity’s Graham Smith. But as the global economy recovers and the impact of Covid lessens, he sees more traditional types of company returning to favour, including oil producers, banks and miners.
He also suggests that rising interest rates tend to be bad news for high growth tech companies with lots of cash flows and earnings anticipated way into the future.
Kasper Elmgreen, head of equities at Amundi, agrees that there is good reason to be more wary of techs in the present climate. “The air has been taken out of many of the speculative compartments of the equity market. The multi-year drop in interest rates, which made investors favour long-duration assets – such as ‘growth’ stocks – has reversed. We’re now seeing a reversal of that, which is triggering underperformance in the growth or higher duration parts of the market; while other areas of the market, such as banks and commodities, are doing better.”
He adds “We do believe that this rotation could be significant and prolonged. That’s not to say the trend will be completely linear: there will be bumps on the road. As interest rates are going up, equities are likely to de-rate downwards. Within that, the most sensitive parts of the markets are the long-duration compartments such as the tech sector – and these will be hit hardest.”
Long-term view
Andy Brown, investment director at Abrdn, sees things slightly differently. He argues that while the shift in inflation expectations and rising yields has indeed proven to be a headwind for many high growth technology companies in the first month of the year, for those with a long-term investment horizon many tech stocks look attractive.
But, he adds: “Investors should be aware that the technology sector is not homogenous in any way. Indeed, we would argue that companies like Apple are more akin to a consumer staple business, and foundries such as TSMC are hi-tech industrial companies. What is true, however, is that these companies are enablers of much bigger changes in our world. They often sit at the apex of major shifts in the way we live our lives, and interest rates going up isn’t going to change that.”
Richard Clode, co-manager of the Janus Henderson Global Technology Leaders and Sustainable Future Technologies funds, says that Covid did accelerate some existing tech trends but that it is a mistake to think you want to own banks and mining stocks long-term.
“You can’t talk about ‘all tech’, there is a big difference between growth-at-any price tech and growth tech at a reasonable price. Also, during Covid there were many companies where growth was never going to last forever – such as Peloton. Then there are companies that are just never going to be profitable”.
Two sides to the story
Clode says the hit that tech stocks took in early 2022 was always going to happen but stresses the huge variance in nature of tech businesses listed on the Nasdaq.
To illustrate a balanced view of what has happened in tech, he points to Ark Invest’s flagship ETF which saw managed assets fall 50% from their peak as investors appeared to ‘rotate away from high-growth stocks’. At the same time, he highlights that Berkshire Hathaway’s biggest current holding is Apple.
Tommy Faber, fund manager at Waverton Investment Management, takes a similar line to Clode. “Tech stocks have been hit hard, but within the sector there are various narratives. The prospect of rising interest rates is punitive to some of the more speculative and unprofitable tech companies, whose valuations are more closely tied to future earnings generation.”
He adds: “There has also been significant damage to companies, such as Netflix, who have failed to meet their earnings expectations. However, companies that have continue to grow and meet expectations are still finding support as evidenced by recent strong prints from Apple, Microsoft and Visa.”
Attractive time to buy?
Overall, Amundi’s Elmgreen is underweight tech but he insists there is a need to differentiate between the tech investment environment now and at the time of the tech bubble, just over 20 years ago.
“Unlike in 1999, you now have both very strong and very profitable companies in tech as well as more speculative ones-which dominated more in 1999. For the first group there is little question on the business model – the question was about very high implied expectation – high valuation.”
He adds: “For the second group we have both questionable business models and extremely high valuations. The de-rating has further to go overall, particularly for the speculative group while some select opportunities are starting to emerge in the strong business model and strong earnings generative group of tech.”
David Older, head of equities at Carmignac believes high-multiple tech names remain sensitive to a rising rate environment. However, he says valuations have contracted in recent months, with the Nasdaq forward PE reaching levels seen in May of 2020.
“While we adopt a cautious approach, we find attractive opportunities within the cloud infrastructure and software space, notably cybersecurity, which benefit from strong underlying secular growth.”
