We could loosely group the main headwinds facing technology stocks under four Ps:
1. Progress towards a COVID-19 vaccine
2. Political change in the US
3. Prices that look high
4. Portfolio concentration concerns
Let’s consider each of them in turn.
Progress towards a COVID-19 vaccine
While an effective vaccine could lead to a reversal of the market trends that have benefited the tech sector over the past nine months, not least by sending investors back into cyclicals and value names, we believe tech’s appeal will persist.
A step change in the relative earnings of technology companies versus the rest of the market has long been evident. The pandemic has accelerated these pre-existing trends, which we view as structural. Vaccine news may create some optimism about economic normalisation and stoke the rest of the market higher, which may dampen tech in the short term, but we think the themes driving technology companies support long-term success.
Nonetheless, to address the potential reversal of market trends as the vaccines become available, we remain committed to diversified portfolios. In equities, we have taken a barbell approach that includes exposure to some of the least-loved parts of the market, notably the laggards that should perform well as the real economy recovers. Among these positions is European travel and leisure, which should benefit from the return to normality after having performed so poorly earlier in 2020.
Political change in the US
Many believe Joe Biden’s victory in the US presidential election could spell the end for big tech as the Democrats seek to regulate the sector more tightly. The impact of the new administration may well be overstated in this regard, though. Biden has not shown a particular passion for tech regulation during the campaign or his long prior political career. The presence of individuals with big-tech backgrounds in Biden’s transition team also suggests he is not overtly against the sector.
In the medium term, we think the US has little incentive to overregulate the sector due to its battle for tech supremacy against China. We believe the rising tension between the US and China will be the most important driver of geopolitics over the next 10 years as both sides seek to avoid the Thucydides trap. While Biden’s diplomatic style and tone may be more traditional than Trump’s, we don’t believe foreign policy towards America’s growing rival will change significantly in substance.
That said, we would still expect there to be an acceleration of antitrust investigations into big tech and beyond, not just relative to the low-regulation Trump era but because elements of the Republican party too seem agitated about perceived censorship by the social-media giants. Such investigations and their conclusions have hitherto been somewhat toothless, however.
Prices that look high
Valuations in the technology sector are not currently a problem, in our view. We cannot argue it is cheap, but it is not expensive either. Tech does trade at a premium to the rest of the market, but its price-to-earnings ratio relative to other sectors has not increased despite its outperformance this year. Its rally this year, and indeed over most of the past decade, has been driven more by superior earnings growth than a rerating. This is a big difference from the 1990s tech bubble.
Portfolio concentration concerns
The concentration conundrum, which can leave investors exposed to an undesirable degree of idiosyncratic risk, nevertheless remains a concern for us. To combat this in portfolios, we can focus on sub-segments of the tech space, such as artificial intelligence. This can give us tech exposure without the mega-cap bias and with less of the regulatory risk associated with the politically sensitive or near-monopoly names.
Overall, then, we are mindful of the potential headwinds, but believe they are more than offset by tailwinds.