Technology bubble

During the recent volatility seen in global equity markets, the technology sector has come to the fore and has, to an extent, polarised opinions. Some commentators are calling the end of the bull market in technology stocks and prophesising a crash akin to the dot-com bubble of 2000, while others remain optimistic and cite increased opportunities following the recent sell-off.

The sell-off was surprising in some regards given that news flow has been light and there hasn’t been much material downgrading or earnings revisions in the sector.

Therefore, fundamentals have remained largely unchanged heading into earnings season and the more likely explanation of the volatility is that price appreciation of the ‘leading edge’ tech names market had moved ahead of itself and the risk of rising tensions in Ukraine and growth concerns in China saw a reversal of this.

During this period, we have seen a rotation towards the older, incumbent names deemed to be more defensive. Names such as Microsoft, IBM and Oracle held up better than cloud computing and social media names
e.g. Twitter and LinkedIn.

There have only been three occasions when ‘internet names’ (those deemed to be at the forefront of tech advances) have underperformed the broader sector by more than 12 to 15 per cent: 2008 during the financial crisis, 2011 during the eurozone debt crisis and the current period of volatility.

In light of this, and the lack of change in fundamentals, it appears that we are more likely to be near the bottom of this correction and that the sector as
a whole is not a bubble set to burst.

As with most sectors, there are over- and undervalued companies and there will be winners and losers. One aspect to consider is that traditional valuation metrics aren’t always suitable for these types of companies, particularly where its lifecycle and potential to generate value can be drastically compressed compared with an average PLC.

For example, the value created by Facebook within ten years and WhatsApp within four years, would have been hard to fathom even up until recently. So while valuations may appear rich on the basis of something like price to earnings, deeper analysis may prove this to be misleading in certain instances.

Consensus does seem to have formed regarding a possible bubble in IPO. The market for newly listed companies in the sector has been particularly active and it has not been uncommon for firms to jump to large premiums on the first
day of trading.

Some of these potentially overhyped companies, benefitting from their association with cloud computing and social media, have come to market without a clear strategy for profit generation and little in the way of visible earnings. These are exactly the type of companies vulnerable to a downturn in sentiment and investors should tread carefully in this space.

Ultimately, there will continue to be a wide disparity between the prospects for winners and losers within technology and a strategy to selectively pick these winners remains crucial. Industry is increasingly reliant on the sector and it is widely accepted that firms must embrace technological advances to enhance profits and remain competitive.

The recent pullback and blanket selling of ‘leading edge’ names has been healthy to a certain extent, giving investors the opportunity to invest in themes and names they like at a cheaper price. Currently, an active approach seems particularly sensible and it is important to be selective in this stock-pickers market.

Moving into earnings season, initial results appear to be positive with firms such as Facebook posting an 82 per cent year-on-year rise in advertising revenue, increasing investor confidence that the company can monetise its popularity.

As long as global growth remains supportive and earnings move in line with expectations, winners within the technology sector should be in a position to provide healthy returns.

Claire Bennison is regional director at Brooks Macdonald in Manchester

She writes a regular in-practice article on asset management for Private Client Adviser

This article was published in the June 2014 issue