The last time I wrote about technology stocks the world looked very different. In mid-February the market was at an all-time high, unemployment was at a 50-year low and investors were starting to contemplate a Sanders Presidency.
Despite all that has happened, tech stocks are up for the year. This compares to a -9% return for the S&P 500 and a meltdown in most cyclical sectors. While the future shape and speed of the recovery is still very much in doubt, I still believe tech and tech-related names can lead the market, particularly if volatility returns. Here is an update on the three reasons I gave back in February and why they’re still valid today.
1. Earnings and cash flow remain resilient.
Previously I highlighted that tech valuations were justified based on exceptional profitability. While tech earnings have been hit along with everyone else, they are holding up remarkably well (see Chart 1). This is not surprising. Although the lockdown is crushing spending, tech continues to dominate wallet share, both for individuals and companies. A recent Fortune 500 CEO poll found that 75% of companies plan to increase technology spending.
2. Central banks have pulled out all the stops.
As discussed back in February, rising liquidity has historically favored technology shares. The virus and lock-down have led to the fastest contraction since the Great Depression, and central banks have responded in a rapid and unprecedented manner. One metric – growth in major central bank balance sheets plus emerging market ex-China reserves – is growing at nearly 17% year-over-year, the fastest pace since 2012. In the past, much of this newly created money finds its way into financial markets and has disproportionately benefited technology shares.
3. If there is a winner in this crisis, it is technology.
Many of the business and broader societal changes demanded by the virus accelerate existing trends: internet commerce, cloud computing, gaming, streaming and remote communication. One example: retail e-commerce spending is up nearly 60% year-over-year. While some of this is temporary and should reverse as the crisis fades, many of these trends will remain long after COVID 19 has been defeated.
Risks: politics and a vaccine
Given the magnitude of the run, it is fair to ask what could derail the trend. I can think of at least two developments: politics and an unexpectedly rapid vaccine. On the former, it is easy to forget that a potentially seismic election is less than six months away. Depending on the outcome, the policy environment could shift in ways less favorable for large tech firms.
Ironically, another development that could derail tech’s winning streak would be a rapid “V” shaped recovery on the back of an imminent, safe and effective vaccine. Under this scenario investors would probably rotate into beaten up cyclicals, which stand to benefit the most from a quick return to normalcy. In the absence of either, tech may prove more of a defensive bet than many suppose.