Tech’s not invincible – but I still like it

The market reaction to disappointing Facebook results indicate investors are less bullish towards tech than surveys suggest

For a sector accustomed to getting headlines for its stellar growth and equity returns, this week felt a bit different. While Alphabet and Amazon delivered another set of expectation-beating quarterly results, Facebook, for the second time this year, crashed the party. 

Time to take stock, think about what we’ve learnt and revisit our bullish macro case for the tech sector. In short, I still like tech.

As bad as the market’s reaction was, it’s important to keep two key things in mind when interpreting the information contained in Facebook’s results. First, the sell-off comes after a big rally and sharply raised investor expectations. Even the 19 per cent correction on the day still leaves Facebook shares trading 19 per cent above the lows during the Cambridge Analytica scandal. 

Secondly, the disappointment is largely down to company-specific issues. Facebook’s reduced revenue growth guidance seems predominately due to a business decision to shift focus to a part of the business that (so far) is less well monetised. This offers limited read-across to the rest of the sector.

Market reaction around tech results over the past couple of weeks has revealed that positioning isn’t as bullish as some indicators suggest. 

It feels as though week after week, investor surveys tell us that tech is the most consensus-long sector  in the market. But one of the criticisms of using investor surveys as an indication of positioning could apply here. Sometimes surveys can be more a reflection of how investors wish they were positioned than how they are actually positioned. 

You would expect a sector with super-bullish sentiment and positioning to be over-sensitive to even small bits of bad news. But the market had two opportunities to punish the wider sector on bad news flow, yet it took neither. Netflix and Facebook, two of the high-profile FAANG stocks, disappointed markets and yet there was no spillover and the rest of the tech sector traded up on both days.

The market reaction to Facebook’s results has been a useful reminder that the sector is not invincible. Some of the biggest tech bulls argue the sector is a ‘buy’ even in the next recession. I disagree. 

Business models may not be the most cyclical in the market and some tech companies may even take market share from traditional competition in a recession, but Facebook’s experience showed how sensitive share prices are to question marks over the growth trajectory. 

In a recession and accompanying bear market, investors will be less willing to attribute value to the uncertain growth potential in the distant future.

Taking a quick look at our original macro buy case for tech, the arguments remain valid today. Though not part of our base case, a retail-driven equity bubble remains a possibility and we see tech as a prime beneficiary of a late-cycle equity melt-up scenario.

 

The USD economy continues its progress towards late-cycle, where tech’s low labour cost exposure, high margins and high cash balance should be supportive factors. With outperformance roughly matching relative earnings, the valuation premium of tech remains a manageable 10 per cent on a  price/earnings basis. Our greatest concern remains a regulatory ‘Techlash’, but post-Cambridge Analytica there seems to be no escalation in this risk.

 

Lars Kreckel is global equity strategist at Legal & General Investment Management

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