The S&P 500 is increasingly dominated by new-economy technology firms, with high cash balances, minimal debt, and expensive valuations. The growth trends feel unstoppable, but future regulation could bring an end to their dominance.
Tech stocks are more dominant than ever
Today Apple, Microsoft, Amazon, Facebook and Alphabet (Google’s parent company) account for 14% of the MSCI World Index, with a market cap just shy of $7tn. To put this in perspective, this is the same size as the combined weight of all the listed companies in the UK, Switzerland, France and Germany.
Within the S&P 500, Information Technology (28%) dwarfs every other sector, even with Amazon (4.8%), Facebook (2.2%) and Alphabet (3.2%) tucked away into other parts of the classification. In short, tech allocations have been, and will continue to be, a vitally important determinant of investment returns.
For all its disruption, the coronavirus pandemic has achieved an acceleration of the adoption of technology, whether to shop, videoconference clients and colleagues, or to spend leisure time on Netflix and social media portals. In the short term, these trends feel unbreakable; like it or not, working from home, cloud computing, and opening the front door for deliveries a number of times a day, are likely to stay with us in part, or in whole, forever.
But for an asset allocator, the key question to consider is whether the next five years will largely resemble the previous five?
Valuations are just one part to consider. Amazon trades on a forward price to earnings ratio of 67x, which for a normal company is nose-bleed levels. But Amazon is not normal. It has crushed its bricks and mortar competition, taking market share from all the established brands, while simultaneously becoming a leader in cloud computing through Amazon Web Services. Over the past decade its forward price to earnings has oscillated between 40x and 170x earnings – not owning it on near term valuation grounds has been unwise, as a total return of more than 2,400% USD would suggest.
Can anything slow Big Tech’s growth?
Looking ahead, it feels increasingly likely that politics and judicial decisions will be an important part of the answer.
The internet, through its network effect nature has allowed vast empires to accrue to a small number of businesses, that, unthreatened by smaller rivals, have been able to achieve sustainably high margins and fast revenue growth. The recent rise of the Chinese-owned teen-dancing video-app TikTok appears to have been the exception, rather than the rule, and its threat to Facebook soon saw an army of lobbyists pressure the US administration into intervening against it, on what appears to be relatively tenuous grounds of national security.
Another four years of Donald Trump might ordinarily suggest less pressure on Big Tech and more of a continuation of the status quo, but there are already signs that things could change. For example, Epic Games, the owner of Fortnite, is currently challenging Apple and Google in court for forcing it to sell its add-on products through their online stores, thus paying a 30% fee on every user transaction. A win here could significantly harm their margins and potentially allow other developers to break away. European lawmakers could also target tech firms with a series of taxes and legislation.
Combining competition laws, online taxes, and data privacy legislation, with an increasingly hostile US approach to China – a major source of future earnings growth – could begin to see the entrenched advantages of Big Tech begin to get eroded away. For investors, this is a known unknown, but is one that only the very brave (or reckless) can entirely shift their portfolio in anticipation of. Tech is here to stay, but too much is still to be determined; will these businesses continue to make huge profits, growing exponentially, or at the other extreme, could onerous future regulation turn them into something more akin to a water utility? As we move into the tail end of the US election campaign, more will be revealed, but what is certain is that portfolio positioning on Big Tech will continue to shape investment returns.