Boris Johnson Not Backing Down and the Technology Stocks Bubble

Today I received an email from the Conservative Party signed by Boris Johnson and entitled “I will not back down”. The first few sentences said:

“We are now entering the final phase of our negotiations with the EU. The EU have been very clear about the timetable. I am too. There needs to be an agreement with our European friends by the time of the European Council on 15 October. If we can’t agree by then, then I do not see that there will be a free trade agreement between us, and we should both accept that and move on. We’ll then have a trading arrangement with the EU like Australia’s. I want to be absolutely clear that, as we have said right from the start, that would be a good outcome for the UK”.

But he says the Government is still working on an agreement to conclude a trade agreement in September. However the Financial Times reported that there are problems appearing because the “UK government’s internal market bill — set to be published on Wednesday — will eliminate the legal force of parts of the politically sensitive protocol on Northern Ireland that was thrashed out by Mr Johnson and the EU in the closing stages of last year’s Brexit talks”. It is suggested that the EU is worried that the Withdrawal Agreement is being undermined. But reporting by the FT tends to be anti-Brexit so perhaps they cannot be relied upon to give a balanced commentary on the issues at present.  

Of course this could all just be grandstanding and posturing by both the UK Government and the EU to try and conclude a deal in their favour at the last minute. But we will have to wait and see what transpires.

Well at least it looks like Brexit news will dominate the media soon rather than the depressing epidemic stories.

Technology Stocks Bubble

Investors seem to have been spooked last week by the falls in the share prices of large technology stocks such as Apple and Tesla (the FAANGs as the group are called). This resulted in overall market falls as the contagion spread to many parts of the market, particularly as such stocks now represent a major part of the overall indices. I am glad to see my portfolio perked up this morning after substantial falls in my holdings of Polar Capital Technology Trust (PCT) and Scottish Mortgage Investment Trust (SMT) both of whom have big holdings in technology growth stocks although they are not index trackers.

I’ll give you my view on the outlook for the sector. Technology focused companies should be better bets in the long-term than traditional businesses such as oil companies, miners and manufacturing ones. There are strong market trends that support that as Ben Rogoff well explained in his AGM presentation for PCT which I mentioned in a previous blog post.

But in the short term, some of the valuations seem somewhat irrational. For example I consider Tesla to be overvalued because although it has some great technology it is still in essence a car manufacturer and others are catching up fast. Buying Tesla shares is basically a bet on whether it can conquer the world and I don’t like to take those kinds of bets because the answer is unpredictable with any certainty. I would neither buy the shares nor short them for that reason at this time. But Tesla is not the whole technology sector.

Some technology share valuations may be irrational at present, but shares and markets can stay irrational for a very long time as different investors take different views and have different risk acceptance. In summary I would simply wait to see if there is any certain trend before deciding to buy or sell such shares or the shares of investment trusts or funds focused on the sector.

Investment trusts are particularly tricky when markets are volatile as they often have relatively low liquidity and if stocks go out of favour, discounts can abruptly widen. Trading in and out of those kinds of shares can be very expensive and should be avoided in my view.

I don’t think we are in a technology stocks bubble like in the dot.com era and which I survived when anyone could sell any half-baked technology business for oodles of money to unsophisticated investors. But it is worth keeping an eye on the trends and the valuations of such businesses. Very high prospective/adjusted p/e ratios or very high price/sales ratios are still to be avoided. And companies that are not making any profits or not generating any free cash flow are ones of which to be particularly wary (Ocado is an example – a food delivery company aiming to revolutionize the market using technology). Even if the valuations are high, if a company is achieving high revenue growth, as Ocado is, then it might be able to grow into the valuation in due course but sometimes it just takes too long for them to do so. They risk being overtaken by even newer technologies or financially stronger competitors with better marketing.

Investors, particularly institutional ones, often feel they have to invest in the big growth companies because they cannot risk standing back from the action and need to hold those firms in the sector that are the big players. Index hugging also contributes to this dynamic as “herding” psychology prevails. But private investors can of course be more choosy.

This is where backing investment trust or fund managers who have demonstrable long-term record of backing the winners rather than you buying individual stocks can be wise. Keeping track of the factors that might affect the profits of Apple or Tesla for an individual investor can be very difficult. Industry insiders will know a lot more and professional analysts can spend a lot more time on researching them than can private investors. It is probably better for private investors to look at smaller companies if they want to buy individual stocks, i.e. ones that are less researched and are somewhat simpler businesses.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Tech Stocks Bubble Bursting? And Is Stockpicking a Waste of Time?

The bubble in technology stocks seems to be bursting. There were a couple of interesting articles published in Shares Magazine and in the Financial Times this week. The first was headlined “Tech Stock Mania”. It suggested investors had been piling into technology stocks in volumes not seen since the dotcom bubble of 1993/2000 which I well remember. That was an age when the market valuations of such companies became totally detached from reality and the fundamentals on which you value companies. The mantra was that growth was everything to capture market share in the brave new computer software and internet world. Is it different now?

Technology stocks have been attractive of late because revenue growth is still there and the avoidance of personal contact has driven the need for more digitization and for new software products. Shopping has moved decisively to the internet and video tools and social media have become more widely used. Zoom’s share price has risen by 260% since the start of 2020 and electric car maker Tesla almost as much making the company the most valuable car producer in the world, even though they produce relatively few cars. There was a general rise in all the big technology shares this year until a sell-off in mid-July. It appeared that the increase in valuations was being driven by momentum as investors bought in response to share price rises, which is a great merry-go-round if you can jump on and off at the right point. Just looking at the vertiginous charts of some of these companies can spook you. It’s not that I am a great follower of charts, but when I see a rise in the share price faster than any growth in sales or profits, then this tells me that the market is getting over-excited.

I am of course a great believer in the merit of technology companies where growth can be achieved but past technology giants did not always grow for ever – IBM, Hewlett-Packard and Oracle are good examples. Management errors in not keeping up with technology and market changes are usually the cause, i.e. they collapse like empires from their own internal weaknesses.

I have to admit to recently selling a few shares in the large investment trusts that invest in technology companies – you can guess which they are. The private investors and institutions who buy the shares in such trusts may have even less real view of what is happening in the real world and hence their share price discounts have shrunk to zero or are even negative.

The mega-cap technology stocks such as Apple, Microsoft, Amazon, Alphabet and Facebook now represent more than a fifth of the US stock market according to an article in the FT. That is surely a dangerous level of concentration. Investors seem to think that such companies are not just defensive because of their near-monopoly control of certain markets, but that they still have growth opportunities. They may be right but there is a limit to how much you should pay for any business when the valuation is founded on future growth. Sometimes the growth disappears as markets become saturated and the valuation then crashes as valuations are a discounted calculation of future earnings.

The big winners from the technology boom have been stock-pickers. But Chris Dillow wrote an article for Investors Chronicle a week ago that was headlined “The Impossibility of Long-Term Stockpicking”. It argued that because few listed stocks survive for many years on the market, you are wasting your time stock-picking. Also only 1.3% of shares accounted for all the rise in global markets between 1990 and 2018 according to academic research. The three companies that accounted for 6% of it were Apple, Microsoft and Amazon which were never sure bets if you look at their history.

Mr Dillow therefore argues that as you have no hope of picking the winners you might as well buy an index tracking fund, and you would have done better to hold cash than invest in small cap stocks on AIM.

The article is well worth reading but I am not convinced. My investment portfolio has done better than the FTSE-Allshare over the last 20 years. It might apply to unsophisticated investors that an index tracker may give a good return with minimal effort but you do have to take into account the management charges. You also need to consider what index to follow – global index tracker of large companies perhaps? If so you will have significant exposure to currency risk and the fact that large companies generally underperform. You still have to make some investment decisions and they won’t be any easier than studying individual companies.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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