As has been the case so often in the past, technology shares (with their higher than average beta) are hit hard when markets get nervous and fall sharply. The increased trade tensions between China and the US, and rising risk in Europe from Italy and Brexit, have served to re-focus market attention on the trajectory of economic growth globally, as well as the speed at which interest rates could rise in the US. The result has been a very sharp sell-off across global markets that has exceeded any corrections seen in recent years. Indeed, such has been the magnitude of the fall and subsequent rotation that equity funds across many strategies have been negatively impacted. Those quick to forecast doom and gloom have seized on traditionally fertile areas for selling in the technology space: China / the internet because of the trade wars; storage and memory because of the feared economic slow-down; and large cap technology because they are over owned. From a fundamental point of view, this stance could not be more wrong. We believe the evolution of disruptive technology has never been as strong or growing as fast as it is today. We would countenance investors to dissect the anatomy of the last major market correction, during the great financial crisis in 2008-09, as a guide to what will likely unfold this time.
We looked back at the 2007/8 period (as we did in early 2016 when investors struggled with the sell-off at that time) to consider some of the ‘then’ leading tech names, such as Salesforce and Amazon, performed. Salesforce was the only real Software as a Service (SaaS) company around at that time. It experienced some degradation in sales during the massive economic upheaval – there were downwards revisions of 10% to 2009 sales numbers. The shares fell sharply early in the development of the crisis; they bottomed in late 2008, ahead of the market bottom (down about 60%), and then rallied strongly. In fact, the shares have risen 24x from their 2008 lows to the end of October 2018. The market had mistakenly assumed the economic downturn affected all companies equally and therefore punished a company that ultimately emerged relatively unscathed from it. Amazon is the other company with a long enough history to use as a comparison. It saw its share price fall 60% during the crisis; at the same time it revised its sales forecast for 2009 from $25bn to a low of $21.5bn (forecast in January 2009). By the end of 2009, realised sales were back up to $24bn. So to be clear, they continued to grow rapidly and the financial crisis cost them a mere 4% in sales relative to expectations pre-crisis. The shares bottomed in late 2008, a full 5 months ahead of the bottom in the market, and have rallied 34x to the end of October 2018.
The point we want to make here is that for as long as the huge disruption in technology continues, there will be strong companies that have the ability to carve out substantial markets for themselves. Therefore, we believe sell-offs in broader markets, which lead technology shares sharply lower, should be viewed as attractive opportunities to have another bite at the Apple (no pun intended!). We have tried to explain the case for growth technology versus value many times in the past, but with a one way bull market over the last 10 years this has often fallen on deaf ears. Indeed, focusing on pure technology it has been worthwhile to back high-yielding, cash generative companies (like Apple) and semiconductor stocks. Yet, when markets go through a full cycle, these (more cyclical) companies are unlikely to recover as fast as their growth counterparts because in many cases we would expect them to suffer a significant degradation in growth together with the margin and multiple contraction that goes with that.
It is our central thesis that whatever the impending downturn ultimately looks like, the growth prospects of leading technology names will not be significantly affected by it. Unlike the sell-off in early 2018, this recent downturn has been far broader and therefore now offers a chance to extend positions in many more names at attractive prices, in our view. A recent report by Citi showed that while the S&P technology sector saw only 8% of its constituents fall more than 20% in February 2018, the October 2018 sell-off saw almost 40% of stocks decline over 20%. Within our list of targets we have seen stocks decline as much as -61% and are starting to invest back into these names. In our view, investors should do the same. It will never be easy to precisely time the bottom, but we believe markets are already a long way down and so risk/reward is more favourable. Rather than trying to decide if this is the end for technology or if this is the bottom, we choose to look at the evidence of 2007-09 and feel this must be viewed as a buying opportunity.