Bet it on Tech

It is no secret that technology companies have become the driving force behind U.S. stock markets’ recent performance.  Investors topple over each other to pour money into these companies, seduced by the promise of endless growth and impressive earnings-beats. This is reflected in their disproportionate weighting in U.S. stock markets; tech companies account for just under a quarter of the S&P 500’s cumulative market capitalization. Many see this as part of a natural shift in the macro-economy away from more traditional industries like manufacturing. However, others warn the industry as horribly overvalued and point to the similarities of today’s stock market from that of dot-com bubble of the late 1990s to early 2000s as proof.

The stars of U.S. tech can be found under one acronym: FAANG. This stands for Facebook, Amazon, Apple, Netflix, and Alphabet (owner of Google) –five stocks which together account for 27% of the Nasdaq Index and are single handedly responsible for a quarter of the S&P 500’s 28.4% rise in 2017. The biggest of these is Apple, with a current valuation of over $ 900 billion. Recently, Apple’s stock was greatly helped by news that Berkshire Hathaway would become one of its top five institutional shareholders. This is an uncharacteristic move from its legendary CEO Warren Buffett, who as a devout value investor is always careful not to pay too much for a company. Many see this as confirmation that the highly valued tech stocks, such as the FAANGs, still have some ways to go and are not overpriced despite their stellar recent performance. Others point to Facebook and its recovery from the Cambridge Analytica scandal as an example of how powerful tech companies can become, to the point where they seem almost above the law.

Adding to the size of tech are foreign companies listed on U.S stock exchanges under American Depositary Receipts (ADR), particularly those from China. Thanks to ADRs, investors can buy and sell shares of hot Chinese tech companies which may not even do business outside of China, such as Baidu. Perhaps the most noteworthy example is e-commerce titan Alibaba, which is similar to Amazon in its business model and currently has a market capitalization of over $ 500 billion. The number of Chinese tech listings on U.S stock exchanges is expected to increase in the future as these companies flock to the size and liquidity of U.S. markets to seek capital to maintain their rapid growth.

Tech companies tend to be the winners in a bull market, and this bull market is no exception. However, this does not come without consequences for the stock market and the economy as a whole. Firstly, their disproportionate weighting contributes to the overall volatility of U.S. stock markets given the high uncertainties of the industry. This volatility is exacerbated by foreign companies listed on these exchanges as these have become vulnerable to trade-worry fears in recent months, particularly tech stocks from China. Secondly, not only has the size of tech contributed to volatility but its outperformance of other industries has blurred the actual performance of U.S. stock markets. While the S&P 500 rose just under twenty percent in 2017, adjusting the index by removing the high-performing tech stocks reveals a much more meagre result. This gives fund managers, whose performance is measured against such benchmark indexes, little choice but to jump on the bandwagon and invest in tech stocks as well. This forms an almost self-fulfilling prophecy, further escalating the prices and hence weight of these stocks in the overall market.

Recent developments show no signs of U.S tech slowing down as investors continue to be tempted by companies such as the high-performing FAANG in what is becoming the longest bull market in U.S.  history. This has many worried; at the height of the dot-com bubble tech stocks accounted for 34% of the S&P 500 while in today’s market they have a weight of 25%, which is not far off. Given the exponential increase in digitalisation and automation, it remains to be seen whether this growth really can be justified or whether we should be worried about overvaluation and an inevitable correction –with global consequences.

Written by Jasper Thouin