It has been a dismal start to the year for some of the world’s largest technology companies as earnings have slowed and their high valuations have been called into question. Is the future as bright for the glory sector of the 2010s?
Technology has seen an extraordinary run since the global financial crisis. In the ten years to June 2022 the technology-focused Nasdaq index rose 275% with individual names, such as Amazon and Tesla, delivering an even stronger performance. Tesla shares
were just $6 in 2010; at the time of writing, they are $735.
The strength of technology shares has seen them become a larger and larger part of global indices. The S&P 500, for example, now has 27% in the technology sector. This doesn’t include Amazon, Alphabet (Google’s parent company) or Tesla, which are considered
consumer or communications companies. As a result, technology is now a significant part of many investors’ portfolios.
However, the share prices for the large technology providers have come down to earth with a bump. In all but one of the six months since the start of 2022, the Nasdaq has dropped in value. In April alone it dropped more than 13%. Some of the bellwether technology
names have lost even more:
the share price for Meta (Facebook) has dropped from a peak of over $380 to, at the time of writing, $196. Amazon has lost around one-third of its value, while streaming service Netflix is down almost 70% from its previous peak.
The end of the party?
Is this the end of the technology trade that has proved so popular and enriching for investors? Certainly, there are cracks appearing for some of the major technology companies. Netflix has been a high-profile laggard, losing subscribers as competition among
streaming services has accelerated. However, privacy and data concerns have prompted investors to question the advertising-driven business models of groups such as Meta and Google, while shoppers have not converted to ecommerce with the vigour many expected
in the wake of the pandemic.
There are also valuation considerations. As inflation rises, it is pushing interest rates higher. That means that the long-term cash flows offered by the technology giants are no longer as valuable as they were when interest rates were lower. Many of the
technology giants were ‘priced for perfection’ and, when the environment turned sour, investors were no longer willing to support these lofty valuations. The fact that technology companies form a significant part of the major indices also creates volatility
as passive investors move money in and out.
However, it would be unwise to write off technology just yet. Technology is still embedding itself in our lives in more and more ways: from cars, to banking, to healthcare. There are major structural trends, such as cloud adoption, digitisation or cyber
security that are persistent and enduring.
The value of cybercrime, for example, is currently $6 trillion, with predictions that it will rise to $10.5 trillion by 2025. That puts it just behind the economies of the US and China in terms of size. There are plenty of companies seeing extraordinary
growth in their earnings as companies and governments fight back against cyber criminals.
Technology is still an important sector in terms of ‘future-proofing’ your portfolio. It is likely to be faster-growing than other sectors because new markets are being created all the time. Even though the technology giants have seen weakness, they are
also investing significantly in next generation technologies, particularly artificial intelligence. Microsoft recently announced it would be buying Nuance, an AI healthcare specialist. Meta (Facebook) has also been investing heavily in AI as part of its move
into the metaverse.
How to invest
Investing in technology has been easy over the past decade. Investors have simply had to buy a Nasdaq or S&P 500 tracker with chunky weightings in the ‘FANG’ names (Facebook (now Meta), Amazon, Netflix, Google/Alphabet). It may not be as simple over the
next decade. Many of the large technology companies that form a large part of these indices face challenges in their core businesses. While they have deep enough pockets to ensure they are on the right side of new innovation, it may be naïve to expect the
level of growth seen over the past decade.
Technology is a fast-moving sector and suits active management. There are a number of specialist investment trusts – Herald, Polar Capital Technology or Allianz Technology Trust, for example – which are run by experienced teams with strong links to Silicon
Valley. While investors may make more money out of an individual company, this will also carry more risk. Technology can quickly become obsolete (remember Friends Reunited, Palm Pilots or Napster?) and it can be worth having an expert on your side.
Nevertheless, for those who prefer a cheap and liquid passive option, there is plenty of choice. There are generalist ETFs based on the Nasdaq or MSCI World Information Technology index, but also ETFs based on cybersecurity indices, or ETFs specialising
in Digitalisation or Semiconductors. These allow investors to take positions in specific parts of the technology complex, which may be faster-growing.
Technology remains an exciting and fast-growing sector. There are always periods when it is unfashionable and investors decide they don’t want to pay for the growth it offers. However, a portfolio would be incomplete without it. It is likely to be the most
important sector in the long-term.