Portfolio picksOct 22 2018

Why we are overweight the tech sector

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Why we are overweight the tech sector

For the most part the data remains constructive for corporate earnings and, therefore, for equity prices.

The US economy in particular continued to display considerable strength, with annualised GDP growth of 4.2 per cent in the second quarter being followed with record highs in small business confidence and 20-year highs in consumer confidence being reported in August.

The 10-year US Treasury yield has also reached levels not seen since 2011. 

President Donald Trump expanded his tariffs on imports from China to a total of $250bn (£192.7bn) of goods in September. The tax revenue resulting from the tariff (all other things being equal) will be $25bn a year, a little over 1 per cent of total Federal tax revenues.

That tax is only just over 0.1 per cent of the US economy so in and of themselves we do not think the tariffs are big enough to disrupt the global economy. But the disruption they will cause to some manufacturing and agricultural industries could make things difficult for certain individual companies.

Apple announced a good set of figures in August which showed that the company still has pricing power despite higher average selling prices for its iPhones.

Here in the UK, the news coverage of the twists and turns in the Brexit negotiations has led to a pick-up in the day-to-day volatility of sterling.

In aggregate, trade-weighted sterling fell just 0.2 per cent over the quarter. We expect sterling to continue to be volatile but it is unlikely to have a clear direction until the Brexit negotiations conclude.

Despite the risks, we continue to find good investment ideas in companies fitting four key attributes: sustainable competitive advantage, opportunity to grow future cashflow, value enhancing management strategy and attractive valuations.

We, therefore, have not made any changes to our overall asset allocation and we maintain our overweight position in equities. 

From a sector perspective, we are marginally overweight the technology sector which has contributed strongly this quarter. We are very focused on technology companies that have the ability to grow their total addressable market and are not exposed to too much regulatory risk.

Our holdings include Apple (up 23.5 per cent), Amazon (up 19.3 per cent), Salesforce (up 18 per cent) and Microsoft (up 17.4 per cent).

Apple announced a good set of figures in August which showed that the company still has pricing power despite higher average selling prices for its iPhones; the company also showed its services businesses (e.g, the App store) are providing very stable revenue growth. Apple’s shares are on just 17 times prospective earnings, which is not expensive given the strength of the company’s franchise and the growth rate.

Amazon, on the other hand, does look expensive on a traditional price to earnings basis. The shares are currently on 85 times prospective earnings per share (EPS).

However, this is much lower than the 170 times the shares were on at the beginning of 2018. It may sound extraordinary, but the fact is Amazon’s shares have got much cheaper in the past nine months, despite the share price going up nearly 75 per cent.

The reason for this is that not only are earnings growing very strongly, but the company is taking steps to grow its addressable market exponentially into sectors such as healthcare. 

Recent additions to the portfolio include Intuit, the US accounting and tax software company, which is now expanding internationally on the back of its leading cloud computing offering.

We bought a holding in Diageo, the global beverage company, which is benefitting from strong market share positions in well established brands such as Johnnie Walker, Smirnoff and Guinness, as well as growing new products - in particular, the fashionable Tequila brand Casamigos recently purchased from George Clooney.

Finally, we bought a holding in the Japanese chemicals company, Showa Denko. The company produces ultra-high performance graphite electrodes which are essential for electric steel production.

We believe that the market is overlooking a shortage of supply in the sector and an increased demand for this type of steel production which, together, should lead to strong pricing power.

We also added to an existing holding in Novo Nordisk. This company has long had an unrivalled franchise in diabetes treatment. In June it presented the results of its Oral Semaglutide trial, which confirmed strong efficacy with low side effects – apart from significant weight loss.  

The company is now trying to develop Semaglutide into an anti-obesity drug. If successful, it could be the biggest pharmaceutical product in the world. 

In conclusion, while we are acutely aware of the risks in the market, the data that we look at suggests that there is further upside in equity markets from here and we therefore maintain our overweight position. 

Alexandra Buchan is co-manager of the Waverton Portfolio fund