As Greece’s markets reopen this week and quarterly reports continue to get dissected, the focus of investors will move to the June jobs report on Friday and its implications on the Fed’s rate hike timetable. So far, according to FactSet, of the 354 companies that have reported earnings for the past quarter, 73% have reported profits above the mean estimate and 52% have reported sales above the mean estimate. All in all, with weak but positive numbers, we believe rate hike discussions will define market movement in the coming weeks. One sector, however, remains a solid buy, in our opinion, due to its massive role in today’s functioning as well as the seemingly immune nature to interest rate changes – technology. Here’s why we think so:
Slim pickings: Unlike the previous decade, there are no BRICS to pave the path ahead for global growth. Europe and Japan are slowly recovering from very low baselines, the US economy remains in the slowest expansion in recent times, and businesses have cut costs, built up cash, but remain cautious regarding spending. Commodities are in a slump, worldwide inflation is at barely 2.5%, according to Yardeni Research (excluding 2009, that’s the lowest level since 1999), and global growth is projected to be only 2.5% this year, according to JP Morgan data. In a yield-starved environment, technology is really one of the few spots where growth – organic, we might add – has been evident – and as a result, the NASDAQ finds itself up over 8.09%, compared to the S&P 500’s 2.14%, the Dow’s -0.09% return, and the MSCI All Country World Index’s 2.97% return YTD.
Now, positive returns are all well and good, but such crowded trades can be worrying. When investors so distinctly rush towards the winners, minor signs of weakness can cause panic among the masses. The thinning breadth of the market winners is a worrying sign, considering the tech giants (Amazon, Apple, Facebook, Google, Netflix along with Gilead) have accounted for over half of the Nasdaq’s gain this year, according to the WSJ. A similar tale exists for the S&P 500, with the addition of Disney. The tech sector itself comprises the largest share of the S&P 500 today, at nearly 20% of the total market weight. However, our worry around overenthusiasm remains capped. Essentially, out of the drivers of growth (say, utilizing the Solow growth model, we take capital accumulation, population growth, and productivity as the three main contributors), we think technology’s role in increasing productivity is incredibly undervalued – simply because there aren’t well-established ways to measure it yet. The boundaries that technology has broken through – essentially in the last 2 decades – is greater than what many would have ever expected. According to the US Chamber of Commerce, 90% of the world’s data was produced in the last two years, while as noted by The Economist, in 2000, 400 million people worldwide had internet access; by the end of this year, it’ll be 3.2 billion people. Mobile payments, health tracking, genome sequencing, cloud storage, remote access, cybersecurity, and other such words have become commonplace – and the markets are paying attention.
Essentially, what we’re seeing is that firms in this sector don’t go about their business model focusing on the traditional for-profit metrics of return on equity, market share, or, say, volume or pricing power – all bedrock corporate focuses for decades. We find that the new age tech firms are greater focused on different drivers – the top three being asset utilization (for example – the sharing economy), data analysis (understanding each action), and information transfer (meaning getting the right information to the seeker – faster). Firms that focus around 2-3 of these three activities efficiently, seem to be the winners – Uber, AirBnB, Dropbox, and the firms noted above all have these traits. Take another example – PlanetLabs. Profiled in Bloomberg Businessweek, this Silicon Valley firm takes pictures from shoe-box sized satellites in space for clients – helping dissect everything from parking lot occupancy signaling sales in far-flung Walmarts, lights in Myanmar showing manufacturing overtime shifts, and crude oil shadows depicting tank levels. The power of data is incredible – and if it can be analyzed and transferred back to the right people (say, government agencies or investors), the potential of value-creation remains massive. An example back on Earth – Taco Bell’s online app is seeing 20% higher bills compared to orders placed in-store, as customers can place them more leisurely, add topping combinations without confusing the counter-staff, and browse a more user-friendly menu. Undoubtedly, the success of Taco Bell (part of Yum Brands) will be replicated by other apps in the future. Another major foray – driver-less cars, are set to make up over 10% of global sales by 2035, according to the BCG, highlighted by Forbes. Road accidents – with 95% caused by human error today, stand to plummet – and as a result, their total cost to society today ($948 billion, or 6% of GDP per year), could be put to far more productive use, according to their analysis. Investors should take note – there’s plenty to come from this sector.
The numbers: Fundamentally, we think the tech sector continues to look solid (on the public side, at least). The sector’s correlation to treasury yields is essentially 0 (JP Morgan data) – meaning it is one of the few fields that could remain immune to Fed rate hikes in the coming months. As of June 30th, the forward P/E for tech was 15.2, signaling an undervaluation compared to the 15-year average of 20.2, and the dividend yield, at 1.5%, was over double its 20-year average of 0.7%. The numbers show that firms are more diligent about returning capital to shareholders – signaling, if anything, additional maturity around cash usage. Take Google, for example – with Ruth Porat’s joining as the CFO, we’re willing to bet that the firm will join the ranks of dividend payers such as Apple in the coming months, further signaling a coming of age for the tech titans.
Granted, caution due to the 2000 bubble experience should remain high, but we aren’t seeing similar warning signs at the moment. Companies are generating real earnings, the cash burn rate is far lower, and P/E ratios remain closer to Earth, unlike back then. As Jim Swanson pointed out in an interview with Barron’s, in March 2000, tech provided 13.5% of the S&P 500’s earnings, but was 33% of the entire market value. Today, it’s 20% of earnings, and just 19% of the market capitalization. Meanwhile, we have been concerned about private valuations, as denoted in our March 8th column – and that still remains. However, we’re less worried in the long term, and would utilize any short term dips to buy the public side for the reasons above. The relationship between developed economies and efficient markets is pretty evident – the more developed the region, the more efficient the market (and vice versa), as assets are priced more appropriately considering the information is greater in quantity, more accessible, and at faster speeds. Technology will drive this efficiency. Last year, according to The Economist, 20% of US business school graduates went to work in technology – the highest level since 2000. 3 of Fortune’s world’s most admired companies are tech firms (4, if you count Starbucks) – and while it’s difficult to value what we call the reinvestment of talent, it’s a simple thought – if the currently-top ranked firms attract top talent, you have to think they’ll be stronger positioned to remain at the top and deliver breakthrough innovations.
What it means for you: The structural trends favor investment here; dips should be treated as long-term buying opportunities for this sector. Consumers and businesses have shown their continued preference and increasing dependence on technology. There’s no reason to think Wall Street’s direction would be any different. Next week, we’ll be visiting the consumer discretionary field, given the data around the reduction in the US personal savings rate from 5.2 to 4.8% in the 2nd quarter and the potential to add to the already-robust 10% YTD returns for the sector. The trends are looking good – stay in sync with them as the markets prepare for the June jobs report on Friday.
