In March 2020, the global economy tanked resulting in the rate of inflation looking like it was headed to zero. Eight Bays have revisited the post sell-off of the big tech 10.
Last time we discussed the Big Tech 10 Stocks was in the middle of November 2021 - pretty close to the peak for tech stocks. The peak for the NASDAQ was in fact the day after Boxing Day in 2021. Presently the NASDAQ has fallen by 16% but been off as much as 21% since that high.
Clearly a lot has changed in world - a war in the Ukraine, a slump in the second largest economy in the world (China), the Federal Reserve raising interest rates from 0.25% to 0.50% and looking to end QE as it strives to bring down inflation. As a result, long-term bond rates have risen dramatically with the US 10-year Bond nudging 3% from 1.5% when we last discussed the tech giants.
In fact, looking at the backdrop of all these negative monetary, economic and geopolitical factors, it seems surprising that the higher PE sectors in the global equity market have fallen so modestly. However, market cap weighted indices sometimes don’t reveal the real picture of events in equity markets given mega caps Apple, Microsoft and Amazon (15% of the NASDAQ) have held up better than the tail.
These negative macroeconomic and geopolitical events are clearly going to weigh upon the upcoming earnings season. How much is hard to gauge, but from experience we suspect there will be downgrades across many sectors, barring some commodity sectors which are benefiting from the supply driven constraints caused by the war in Europe.
So where are we in terms of investing fundamentals for the mega cap tech stocks? Beginning with earnings, the Big 10 have continued to deliver growth over a 6-month period to December 2021. Operating cash flow for the group has expanded by 8% with just Amazon reporting negative cash flow growth (-22%). Taiwan Semiconductor and Tesla experienced impressive growth in operating cash flow - 30% for TSM and 25% for TSLA. In terms of cash flow multiples, the Group has experienced a 12.5% fall from 27.3x to 23.9x with Meta and Nvidia suffering the largest re-rating (-37%). Apple and Amazon have shown the most resilience with Apple experiencing a 6% positive rerating and Amazon maintaining its multiple.
To summarize, the re-rating of the Big Ten Tech stocks has not mirrored the change in bond yield which has expanded by 74% for the period reviewed. However, most equities it could be argued were never pricing in 1.5% bond rates into perpetuity. Stocks tend be priced on long term expected average bond yields. We note that that the US 10-year bond has averaged around 2% over a rolling 5 years.
Will this rolling 5-year average rate rise in the future? Quite possibly if we experience sustainably high rates of inflation. Some recent analysis by Charles Goodhart, an influential economist suggests we may see high rates of inflation that has been the case in the last twenty years. To quote a recent article in the Wall Street Journal;
“Mr. Goodhart reasoned that a seismic shift was under way in the world economy, one that fiscal stimulus and the post-pandemic recovery would only hasten. A long glut of inexpensive labor that had kept prices and wages down for decades, he said, was giving way to an era of worker shortages, and hence higher prices.”
We believe that rising bond yields clearly present short term a headwind to tech sector multiples, however it is quite possibly that much the re-rating has occurred already. If we are to experiencing a further 50bps increase in the 10-year Bond based on the re-pricing delta experienced to date, we could expect a further modest 5-10% decline in capitalization rates. That said we believe a levelling off in long term interest rates see support for the group. Thus, we remain constructive on the longer-term prospects for large cap technology stocks given the strong secular growth prospects across their key industries in which they tend to dominate.
George Clapham, APRIL 2022