Log inAfter a bad year for Technology companies, does 2023 look any brighter? from Charlie Hancock
The share prices of many large technology companies which dominated in the post global financial crisis decade have slumped in 2022. As we approach the end of the year, investors with significant exposure to these companies will be hoping for a quick recovery for share prices in 2023, however, we believe the market may continue to favour other areas for the foreseeable future.
In the 2010-2020 period, the ‘FAANG’ basket of stocks, comprising Facebook (now Meta Inc), Apple, Amazon, Netflix and Google (Alphabet Inc), became increasingly popular. Stock market leadership was incredibly narrow and the FAANG stocks, together with several others, drove US equity indices to record highs. In 2020, the FAANG stocks accounted for almost 50% of the total market capitalisation for the NASDAQ 100 index, a situation which we felt would be unsustainable. As shown in the chart below, the NASDAQ has significantly underperformed against the Dow Jones Industrial Average index this year, with the latter having much less exposure to technology names and a large weighting in healthcare, industrial and financial companies. The Dow Jones index lagged the NASDAQ by a sizeable margin in the post global financial crisis decade and the reversal of fortunes shown below could be the start of a protracted shift in markets.
Interest rates remained at record lows during the post global financial crisis decade. In this environment, the market inflated the valuations of technology companies who were expected to generate most of their profits a long way into the future, whilst shunning high yielding dividend payers, such as tobacco companies, who are likely to see their earnings deteriorate over the longer term. As well as driving valuations to extreme levels, low interest rates often encourage excessive risk taking, with vast amounts of cheap money in the system seeking out higher returns. One example of excessive risk taking driven by too much liquidity in financial markets is the rise (and subsequent fall) of cryptocurrencies. It is often believed that low interest rates also harm productivity, as the availability of cheap money disincentivises competition between businesses or ideas seeking out capital.
With interest rates rising steeply during 2022, the market dynamic of the 2010-2020 period has started to unwind. Much more emphasis is now being placed on cash flow in the present day, rather than cash flow expected in 10 years’ time. Companies with strong dividend streams are outperforming businesses heavily reinvesting in projects that may not be profitable for many years to come.
Facebook (Meta) have seen their share price decline by 65% this year, with investors disapproving of the $100 billion planned research and development spend for the virtual reality ‘metaverse’. When corporations can borrow money at very low interest rates, investment into projects such as this may not discourage investors, but as borrowing costs rise, the spending becomes less palatable. Following disappointing 3rd quarter earnings, Meta have become the latest tech company to announce job cuts, with 11,000 roles being axed as the company attempts to improve profitability. Snapchat (Snap Inc) cut 20% of their workforce in the summer, whilst Twitter is currently cutting 3,700 roles. Reality appears to be biting for some of the large tech companies, with their outlook over the coming years highly uncertain.
Although we are starting to see some signs of inflation peaking, central banks are likely to continue raising interest rates in the coming months. Policymakers appear cautious about pausing rate hikes prematurely, which could potentially allow inflation to accelerate again. As a result, we are unlikely to see interest rates return to record lows anytime soon and the valuations of some large cap technology companies may remain under pressure. Given that these companies account for a significant proportion of many global investment funds, we believe it is important to be selective with our asset allocation decisions to remain underweight in these areas of the market. We continue to favour companies with strong cash flow generation and sensible balance sheets and, as the market continues to adjust to a higher interest rate environment, we feel these areas will maintain their outperformance versus the ‘market darlings’ of the 2010-2020 decade.