Technology “Bubble” Fears Don’t Hold Up

3D Rendering, old tv sets

Upon hearing of his obituary, Mark Twain famously quipped, “The reports of my death are greatly exaggerated.” A similar rebuke could be used for those claiming that technology stocks are back in bubble territory.

While technology stocks are having another stellar year in an otherwise languid market, their outperformance has been driven primarily through stellar earnings, not obscene multiple expansion. Since the start of 2010, the trailing price-to-earnings ratio (P/E) for the S&P 500 Technology Sector Index has risen approximately 20%, only slightly faster than the 14% for the S&P 500 Index. A quick look at top-line valuations confirms that 2018 is not the late ’90s redux.

1. Absolute sector valuation is below average.

At 23 times trailing earnings, the sector is trading at a discount to the long-term average of 28. To be fair, the long-term average is distorted by the bubble years, when the sector traded as high as 70 times earnings. Using the median, a statistical measure less influenced by outliers, suggests that today’s valuation is right in line with the long-term norm.

2. Relative value also looks reasonable.

SP500 Relative Valuation

The technology sector trades at an 11% premium to the broader market. While this is up from a couple of years ago when the sector traded at a small discount, the current premium appears very reasonable in light of recent history. Again, excluding the bubble years, the current relative valuation is actually a bit below the 15-year average (see Chart 1). Using cash-flow rather than earnings provides a similar picture: On a P/CF basis the sector is trading at about an 18% premium to the market, below the historical median of 30%.

3. The sector remains very profitable.

With a return-on-equity of 20%, the sector remains profitable relative to both its history as well as the broader market. The current return on equity is six percentage points above the broader marketThis compares favorably to the long-term median of around four percentage points.

Vulnerable to disruption

To be clear, every technology company remains vulnerable to being disrupted by a slightly more clever version of itself. A sobering reminder of this reality: On the eve of the financial crisis, Nokia’s smartphone market share was approximately 45%, the iPhone was less than one year old and Facebook was barely out of the dorm room. Pessimists will see this as a sign that the sector’s premium is unwarranted given the accelerating pace of innovation.

Although the pessimists have a point, the overall sector continues to be extraordinarily profitable, and, despite rumors to the contrary, reasonably valued. In an environment in which every company, in and outside tech, is vulnerable to being blindsided by an unheard of competitor or innovation, the tech sector is still delivering. It is worth a modest premium.

Russ Koesterich, CFA, is Portfolio Manager for BlackRock’s Global Allocation team and is a regular contributor to The Blog.

 

Investing involves risks, including possible loss of principal.  Funds that concentrate investments in specific industries, sectors, markets or asset classes may underperform or be more volatile than other industries, sectors, markets or asset classes and than the general securities market.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of June 2018 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader. Past performance is no guarantee of future results. Index performance is shown for illustrative purposes only. You cannot invest directly in an index.

BlackRock makes no representations or warranties regarding the advisability of investing in any product or service offered by CircleBlack. BlackRock has no obligation or liability in connection with the operation, marketing, trading or sale of any product or service offered by CircleBlack.

©2018 BlackRock, Inc. All rights reserved. BLACKROCK is a registered trademark of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. All other marks are the property of their respective owners.

The Case for Technology in 2018

Circuitboard

The performance of technology stocks over the recent past has been striking: In 2017, for example, the information technology sector of the S&P 500 posted a 38% return, while the broader S&P 500 Index gained 22% (Source: Bloomberg data). Perhaps even more impressive is the fact that technology is responsible for almost 30% of the total gains of the S&P 500 Index over the last five years (Source: Bloomberg, as of 2/28/18).

In investing, however, past is not prologue. So the question is: Can the good times roll on? We may not see another year like 2017, but there are three reasons why technology continues to be one of our top sector picks.

Strong earnings momentum

The BlackRock Investment Institute recently upgraded U.S. equities from neutral to overweight on the basis of significant earnings growth expectations driven by a supportive macroeconomic environment—and potentially boosted by fiscal stimulus. This thesis equally applies to technology.

This reporting season, 88% of IT companies in the S&P 500 Index posted positive earnings surprises—the highest proportion of all the sectors—while recording 22.5% aggregate year-on-year earnings growth compared to the broad Index’s 14.3% (Source: BlackRock, Bloomberg, as of 3/5/2018). This has translated into strong equity market performance year-to-date, as depicted below. Notably, the other high-flying sector—consumer discretionary—also includes two tech-powered giants: Amazon and Netflix.

Total Return Earnings Surprises

Significant cash balances

Many established technology companies are cash rich, commanding strong balance sheet positions and ample investment firepower. (Source: Bloomberg, as of 11/2/2018).

This offers a number of potential advantages. First, these companies potentially are insulated from the impact of rising interest rates, and may even benefit. As we recently noted, technology historically has been among the sectors the most insulated from yield curve shifts.

In addition, one of the consequences of the recent tax legislation is the prospect of companies repatriating cash back to the U.S. at favorable rates. This increases the potential for dividends, share buybacks or increased mergers and acquisition activity. At the same time, increasing capital expenditure or research and development (R&D) spending may be supportive of the sector in the longer term.

Investing in long-term trends

The impacts of technological disruption extend beyond the confines of old fashioned sector classifications. As we highlighted in October, investing in technology allows investors to tap into large scale, transformational shifts in the way entire industries operate—whether it be the growth of “big data,” cloud-based enterprise and infrastructure solutions, cyber security or the intrinsic importance of semiconductors. Additionally, the growth of online shopping is displacing traditional brick-and-mortar retail and could change the face of commercial real estate markets. These forces result in the tech sector exhibiting a strong secular growth profile and in our view, help justify a premium in the form of higher valuations.

Investors can choose from a wide range of tech exposures.  For example, exchange traded funds (ETFs) tracking broad technology indexes can include large cap technology stalwarts. Alternatively, ETFs tracking more focused sub-indexes allow investors to target companies with network and cyber security business lines or a software focus. Investors seeking a more economically sensitive exposure may consider a semiconductor ETF, providing access to the growth of companies that design, manufacture or distribute semiconductors—the vital components of many electronics and computer devices.

Bottom line

We believe earnings momentum, strong balance sheets and economy-wide transformational forces of innovation and disruption can help provide both cyclical and structural support for technology stocks in 2018. Investors seeking exposure to technological growth can consider taking a targeted approach to their sector definitions.

Chris Dhanraj is the Head of the ETF Investment Strategy team in iShares and a regular contributor to The Blog.

 

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Investing involves risk, including possible loss of principal.

Funds that concentrate investments in specific industries, sectors, markets or asset classes may under-perform or be more volatile than other industries, sectors, markets or asset classes and than the general securities market.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date indicated and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any of these views will come to pass. Reliance upon information in this post is at the sole discretion of the reader.

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Why the Tech Sector Glass Is Half Full

Old Televisions outdoors - All images from my portfolio - Added some grain.

Technology has been the best-performing sector globally this year, accounting for roughly half of U.S. and emerging market (EM) Asia equity returns so far. Yet investors are torn between optimism on this fast-growing, high-earning sector and skepticism given its meteoric rise and memories of the dot-com bust. Our bias is to the former. We see opportunity in firms that are able to monetize their technology amid structural shifts, as we write in our Global equity outlook Tech for the long run.

Investors have tended to overestimate the near-term effects of technology and underestimate the long-term potential. But we see disruption and transformation across the technology universe creating attractive long-term investment opportunities for both growth and income seekers.

Technological disruption has only just begun: Digital has yet to permeate many industries; e-commerce represents under 10% of all retail sales; traditional devices are becoming connected via the Internet of Things (IoT); and artificial intelligence (AI) is starting to transform processes.

FAANG BAT Stocks

The many intricacies of tech may be outshone by high-flying headline makers: the U.S. FAANG stocks (Facebook, Apple, Amazon, Netflix and Google’s parent Alphabet) and their powerhouse equivalents in China —BAT (Baidu, Alibaba and Tencent). Both groups have propelled their regional stock markets higher year-to-date. FAANG returned 35% compared to 10% for the remainder of the S&P 500, while BAT returned 81% versus 26% for the remainder of the MSCI China Index.

But healthy corporate earnings and upbeat forecasts have been the drivers of technology performance, in our view, not “irrational exuberance.” The sector’s exceptional performance has coincided with outsized earnings growth. Earnings on EM Asia tech stocks have been revised up 45% year-to-date. BAT revisions have been particularly strong, while multiple expansion for Asian tech has been close to zero. The increase in global tech valuations has surpassed the broad market, but we see the move as largely warranted. Our base case: Technology broadly, including players outside the sector label, appear to have legs—even after a strong run.

Many companies beyond the popular acronyms hold appeal for diversified portfolios. Equities have become a critical income source in traditional 60% stock/40% bond portfolios, our analysis shows. Tech can play a lead role: The sector is home to many high-quality mega-cap stocks that offer healthy and growing dividends. Many more companies outside the tech sector label are leveraging data and analytics to evolve their business models. We believe the winners of the race to embrace new technology will be those companies that are least complacent today.

Semiconductors in particular are a story worth a read, we believe. We view them as both the backbone and the future of the tech industry. The once highly cyclical group is benefiting from a more diverse demand base, reduced supply after years of consolidation, and new applications in a data-driven world. But the industry may face real competition from China, which has named semis as a strategic priority.

We do see two would-be obstacles for technology stocks in general. We are worried about profit-taking in the short term, as nervous investors look to lock in gains and redeploy their capital in other opportunities. In the longer run, potential regulation is a concern, as the sector’s size and influence draw the attention of policymakers. Yet strong fundamentals make this sector a long-term buy, in our view. Read more in our full Global equity outlook Tech for the long run.

Kate Moore is BlackRock’s chief equity strategist, and a member of the BlackRock Investment Institute. She is a regular contributor to The Blog.

 

Investing involves risks, including possible loss of principal. There is no guarantee that stocks or stock funds will continue to pay dividends. Investments that concentrate in specific industries, sectors, markets or asset classes may underperform or be more volatile than other industries, sectors, markets or asset classes and than the general securities market.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of September 2017 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader.

©2017 BlackRock, Inc. All rights reserved. BLACKROCK is a registered trademark of BlackRock, Inc., or its subsidiaries in the United States or elsewhere. All other marks are the property of their respective owners.

What’s Behind the Tech Selloff

A stack of table and chairs in a pale blue room

On the surface things appear calm. The S&P 500 remains within 1% of its all-time high and volatility is still barely half the long-term average. However, under the surface things may be starting to churn.

Since last Friday tech stocks have been sold hard, with few obvious catalysts. For example, at the lows on Monday Netflix (NFLX) was down over 10% and Apple (AAPL) off 8%. What is going on?

1. An abrupt reversal of this year’s momentum trade.

In a throwback to the late 1990s, tech has once again become a momentum play. The reversal in tech is part of a broader reversal in momentum stocks, a style in which tech features prominently. Using the MSCI USA Momentum Index as a reference point, it is instructive that Microsoft (MSFT) is the biggest name, with a 5% weight. At the industry level, semiconductors, software and computers represent three of the top four industries.

2. Multiples are much higher.

Bulls can rightly point out that tech valuations pale in comparison to the surreal levels of the late ’90s. Still, multiples have been rising fast. The trailing price-to-earnings (P/E) for the S&P 500 tech sector is up over 35% from last year’s low. At nearly 25x trailing earnings, the sector is the most expensive it has been since the aftermath of the financial crisis, when earnings were depressed. On a price-to-book (P/B) basis, valuations are even more extended. Large cap U.S. technology companies are trading at the highest level since late 2007.

3. The surge in growth has made the entire style expensive.

The surge and recent drop in technology needs to be viewed through a prism, which is: As investors have reconsidered the “Trump trade,” they have reverted to two investment themes–yield and growth. This has left U.S. growth stocks very expensive compared to value stocks. While tech valuations may not be in bubble territory, the ratio of value to growth multiples is starting to bear an eerie resemblance to the late 1990s. As of the end of May, the ratio—based on P/B—was just below 0.33. This is roughly 1.5 standard deviations below average and close to the all-time low of 0.31 reached in February of 2000, right before the tech bubble burst.

Growth vs Value

In some ways, the recent selloff resembles the “quant crash” of 2007. Similar to today, levered funds were seeking to juice returns in a low volatility world while crowding into momentum names. Whether the current disruption is eventually viewed as the first crack in the edifice, as was the case in ’07, or just a temporarily blip in a long-running bull market, remains to be seen. What is clear is that the narrow pursuit of a few story stocks has left the market more fragile than top-line indicators would suggest.

Russ Koesterich, CFA, is Portfolio Manager for BlackRock’s Global Allocation team and is a regular contributor to The Blog.

 

Investing involves risks, including possible loss of principal.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of June 2017 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader. Past performance is no guarantee of future results.

BlackRock makes no representations or warranties regarding the advisability of investing in any product or service offered by CircleBlack. BlackRock has no obligation or liability in connection with the operation, marketing, trading or sale of any product or service offered by CircleBlack.

©2017 BlackRock, Inc. All rights reserved. BLACKROCK is a registered trademark of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. All other marks are the property of their respective owners.