US tech companies have been this year’s undisputed equity market winners and have driven the great equity comeback since March – but the picture has shifted the last week. Tech stocks, in particular, have suffered significant price falls in the US, where the technology-heavy Nasdaq index has fallen about 10%.
Nevertheless, we at Danske Bank continue to see an attractive return potential in US equities generally – and in the IT and communication services sectors in particular.
“A correction is to be expected after the major price increases this year, but we view this merely as a temporary setback. Moreover, releasing some air from the balloon is no bad thing – we don’t want it to explode with a bang because it has been pumped up too hard,” says investment strategist Lars Skovgaard Andersen.
Tech stocks are still among this year’s winners despite the price falls. Why have they performed so well this year?
“First and foremost because tech companies are generally being driven by strong structural growth – in other words, underlying growth that is not conditional on the economic cycle, but rather a shift in the behaviour of consumers and companies towards increased digitalisation. This trend has merely been further fanned by the coronavirus in several areas – for example, in the form of increased e-commerce and a greater need for technology that enables working from home. Moreover, the structural growth of tech companies has been extra attractive for investors at a time when the coronavirus has hit economic growth hard,” says Lars Skovgaard Andersen.
What has triggered the sharp price fall in tech stocks?
“Several factors are at play here – and much is due to so-called technical reasons. As we mentioned, downturns in the wake of major price increases are completely normal as investors take home profits – and this tendency has been reinforced by speculation in tech stocks in the expectation of further price increases. Over the summer, we have seen large investments made via call options, which allow investors to leverage their investments. This has driven prices even higher but can result in pronounced movements in the other direction when investors have to liquidate their investments and sell off their equities. This is what we have seen in the past week.
“In addition, the increased volatility in tech stocks can be self-reinforcing and trigger further equity sell-offs. Greater price volatility results in increased risk in many portfolios and could force institutional investors to sell off equities in order to reduce risk and prevent it exceeding their permitted risk levels.
“Finally, a number of other factors have also hit tech stocks – including a minor flare-up in the trade dispute between the US and China that is currently playing out in the technology area. The Americans have recently blocked a Chinese semi-conductor manufacturer from buying a number of components in the US.”
Do you still see an attractive return potential in tech stocks?
“Yes, the fundamental case of structural growth in technology companies remains intact, though naturally not all technology companies are riding this wave. As in all other sectors, there will be both winners and losers.
For you as an investor, recent price falls could represent a good buying opportunity if you have an underweight in tech companies. However, you should be wary of having too many tech stocks in your portfolio. Positive US job data last week prompted investors to rotate away from technology companies towards more cyclical sectors, which have lost most during the corona crisis, as they would benefit from an economic upswing. This trend could gradually be reinforced in the time ahead, so it is important that you as an investor are also exposed to cyclical sectors, such as financials and industrials.”
What about your overall allocation between equities and bonds?
“Overall, we still have a modest overweight in equities in our portfolios and a corresponding underweight in bonds. In other words, we currently have slightly more equities in our portfolios than we expect to have in the long term. We see a reasonable return potential in equities in the coming year, when we expect an economic upswing to gain traction. Nevertheless, the pace and strength of the upswing are still tinged with considerable uncertainty, just as there is great uncertainty on when a coronavirus vaccine might be ready. Given the high level of uncertainty prevailing at the moment, we continue to see technology companies as some of the best investment opportunities, but remember to always diversify your portfolio.”