Has the Tech stock bubble burst?
The main US indices, the S&P 500 and the Dow, are up 6.5% year to date. The Nasdaq is flat. We are used to many years of tech stock performance, all the way back to 2009 in fact, so why are we lagging so badly in this recovery.
Normally the markets have themes that drive activity, in 2020 it was a combination of Covid, the US election and Brexit. All three of those have passed. Yes, for the market Covid has passed, the market is a discounting mechanism it looks forward not to the present. With the announcement of successful vaccines, the market focused on recovery, when and how strong?
This has led to a significant change in outlook and investment strategy. Two themes now dominate for 2021 and beyond. Value investing is outperforming Growth investing and the ‘Reflation Trade’.
Value versus Growth
Growth investing has lasted over a decade since the last crash in 2009. In that period investors have seen stellar returns chasing growth stocks and that included tech. Growth stocks have momentum so the need to look elsewhere never arises, the S&P 500 rose 200% from 2009 to date. Many boring stocks got left behind, financials, utilities, energy for example.
Now however, it is widely accepted the US market and growth stocks specifically, are dangerously over-valued. US Stocks are now twice the price of a comparable company in any other developed market. Go back to 2010 values were roughly the same. The over performance on the US market has been mainly due to, tech of course, but also due to stock buy backs which have over inflated prices and increased debt levels.
Value Investing is the concept of always investing with a High “Margin of Safety”.
Margin of Safety is the principle of buying a stock at a large discount to its intrinsic value. This provides high-return opportunities and minimizes downside risk.
The market has ignored the concept of value investing for over a decade now, some see it as boring you must wait for returns, while growth and momentum investing can offer immediate gratification. However, the benefit of value investing is the protection against market corrections. Overvalued assets get hit hard by corrections while assets which have a discount to intrinsic value, fare much better.
Over the last decade or so, many sectors of the market have lagged as have geographical regions, banking stocks, utilities energy along with commodities have all underperformed. The European markets have underperformed the US and the UK has underperformed due to Brexit, now there is value everywhere. Moving from Growth to value is now known as the great rotation. Copper is up 60 % oil is up 100%.
Overall, the markets are still underpinned by massive Central Bank and Government support and very-low interest rates, the investment is just concentrated on a different strategy. So, the Dow and the S&P have continued to rise because there is plenty of value stocks available, not so the Nasdaq.
The other issue worrying tech is a potential policy shift from Biden. The amount of stimulus agreed in the US is mind blowing, 900bln from Trump and now 1.9Trln from Biden. Who is going to pay for all that? Higher taxes are on the agenda for sure and stocks do not like that. Top of the agenda could be tech as they have the most money.
Overall, this rotation is driving certain sectors of the US market higher along with other value plays outside the US, but tech is not at the party. To gauge how much and how longer this divergence can sustain we need to look back to the ‘Tech Reck’ of 2000.
I have determined the ‘Teck Wreck’ as the period from what, at the time was the all-time high for the Nasdaq 100, in March 2000 and the bear market low for the Nasdaq 100 in October 2002. A period of roughly 18 months.
Berkshire Hathaway (Value) gained 27.62% during the period, while the Nasdaq 100 (Growth) lost 82.76%. Value outperformed so-called ‘Growth’ by 110.38% during the period.
The Reflation Trade
The reflation trade is based on the prospect for growth post Covid and the industries that will do well. This brings in the demand supply analysis as we know demand is likely to outstrip supply as we will experience a lag in getting back up and running.
The US is likely to outperform the rest of the world initially and growth is expected to be double (8% in 2021) than that in Europe. This has led to expectations that inflation is set to rise. I could write forever on inflation, why we did not get any after all the money printing form 2010 and why we expect it now. Regardless the market is hyped again this time around and that has led to Bond rates rising in the US.
In general, the US cannot afford rates to rise, they have a lot of debt to service, so a battle royal will ensue with the markets, who believe inflation will inevitably lead to a rise in rates. While the FED are committed to keeping rate low.
This will cause jitters on the market and growth stocks could suffer. If the inflation genie really gets out of the bottle, tech stocks will get badly hit. However, as we know value portfolios can and do thrive under these circumstances.
Peter Brown is Managing Director at Baggot Investment Partners.
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