The tech bull market: out with new, in with the old?

Since the end of the global financial crisis a fresh burst of optimism has gripped the US tech sector, aided by plentiful liquidity, and several of the largest US technology companies are among the largest businesses on earth, while also leaving behind a trail of sceptical investors, concerned about the valuations.

FANG stocks

Tom Slater, head of US equities at Baillie Gifford, and manager of several funds that have large exposures to US technology stocks, and specifically the group of companies known as the FAANGs (Facebook, Amazon, Apple, Netflix, and Google, although not everyone includes Apple, which makes the group 'FANG').

He says the major difference for investors now when compared with 1999 is that: “In 1999, really the challenge the investor in technology stocks faced was to try to pick the companies that would win from the rise of new technology, but the difference now is that when it comes to technology, we know who the winners are, so it is not like 1999 at all.”

The outperformance from the FANG stocks was as a result of huge and unexpected – by market standards – disruption-led growth --- Tom Wildgoose, Nomura

Charles Jones, who runs the Waverton Global Equity fund said: “The attractiveness of the internet is that a small amount of capital can be used to deliver a strong value proposition to customers and build a large business extremely quickly, generating high returns on capital and a very great deal of money for investors." 

To varying degrees, all of the FANG stocks have capitalised on this.

Many of the ‘old tech’ companies were founded before the creation of the internet and have either manufactured physical computing equipment or sold software under licence.

The ‘old tech’ businesses which have flourished, most notably Microsoft, have worked hard to sustain or improve their value proposition through investing in ever more impressive hardware, or delivering software in more efficient ways to the end customer (more recently through cloud infrastructure and the Software-as-a-Service model). 

The continued advances in not only consumer and enterprise technology but also industrial automation, will likely remain rapid and a key source of ongoing efficiencies for customers, so that any technology business with a strong or improving value proposition should be able to continue to grow profitably and remain a winner for adviser portfolios.

Conversely, any business which fails to sustain its value to customers may be a very poor investment.

In 2019, Netflix has been the weakest performer since the arrival of new consumer streaming services has eroded its value to the customer, whilst Microsoft and Facebook’s value proposition has remained strong (despite regulatory concerns around the latter) and they have delivered significant share price appreciation to investors. 

In short, it is perhaps better to avoid thinking of ‘FANG’ vs ‘Old Tech’, and focus on how much a company’s product or service is desired by its customers.

Tom Wildgoose, who runs the Nomura Global High Conviction fund says: “As is the case in any sector, you need to be stock specific in your tech sector analysis.

"The outperformance from the FANG stocks was as a result of huge and unexpected – by market standards – disruption-led growth.

"Investors simply did not anticipate the impact of these companies, however this is much better understood now, so such dramatic outperformance seems unlikely.

"Amazon is still on very high valuation multiples and continued outperformance looks challenging, although this has been the case before.

"Netflix is a similar case; again the growth was better than generally expected.

"From here, Amazon’s business looks more defensible than Netflix, which is a positive for the stock, but such high valuations make neither look attractive to us.”

James Thomson, who runs the Rathbones Global Opportunities fund is another global equity manager who is keen on the shares of large US technology companies, though he believes that the company’s that will do best in future have somewhat different characteristics to those that have done well to date.

US advantage

He said: “The enormous advantage the US companies have in terms of technology is not going away, it is a permanent advantage, and as businesses they are very attractive, with lots of recurring revenue and high profit margins.

"Amazon have spent a lot of money growing their business, and that is a stock we own.

"We also own Microsoft, they have started to win a lot of business clients for their cloud computing business, we like that they are winning business clients, and think generally it is an attractive area of growth for companies in the future.”

But while Mr Thomson is optimistic about the prospects for the largest US technology companies over the long-term, he is more cautious about the shorter-term outlook.

This is because the share prices of the big US technology companies have benefited from the popularity of the growth style of investing over the past decade.

The growth style of investing tends to do best when interest rates and GDP growth are relatively low.

This benefits technology companies in two ways.

The first is that most of those businesses do not pay dividends, something which matters less when interest rates are low, because investors who could choose to place the cash in the bank to receive interest payments, have less incentive to do so, and so are more likely to place it in equities.

But after a ten year positive run for growth equities, the second half of 2019 has been a different story, as the value equities have performed better,  and as optimism that the US may avoid recession has grown.

Mr Thomson said if this trend continues then it is likely that big tech stocks will underperform relative to the rest of the market.

Andrew Cole, multi-asset investor at Pictet said: “One further factor that might take some of the shine off the FANG stocks in the year ahead is the increasing importance of ESG factors to a growing proportion of investors.

"Governance issues exist in a number of the more highly valued areas of the market and we’ve seen these concerns damage the pricing of both public and private companies, looking to IPO, in recent months.

"Isn’t it likely that given increased ESG pressures that it is those companies that tick the biggest ESG boxes, where investors will be happier paying increasing multiples?”