Technology: is the game over?

Amid investor despair in the second half of 2018 about the decline of technology stock prices, a little perspective is required. Technology has kept up with global equity market in 2018, despite the stock price retrenchment in the latter part of the year, and the longer term outlook is still largely positive.

2018: a year of two halves

After a decade of almost continuously rising tech prices, including extraordinary gains for the so-called FAANG (Facebook, Apple, Amazon, Netflix and Google) companies, the technology sector suffered an abrupt reversal in the middle of 2018.
Why? Well, with long-term Treasury yields edging above 3%, investors are starting to have an attractive risk-free alternative, and the trade war between the US and China escalating, investors began question earnings assumptions. Around the same time, a number of profit warnings by semi-conductor companies spooked investors and Apple warned its suppliers to cut sales expectations for the latest iPhone. Add to that growing concerns – even if unsupported by market signals- of a future recession, and you have a perfect storm of tech anxiety.
But let’s remember that the correction was about 15%. That is not a crash and is definitely not comparable to the technology-led downturn of 2000.

2019: geopolitics and fundamentals

A reset was inevitable amid unsustainable expectations for tech companies. This reset is actually taking place: tech earnings are predicted to rise by a more modest high single digit number in 2019, which is more or less in line with broad markets.
Perhaps the most important driver in 2019 will be the trade war. Tariffs directly impact revenues, but there are indirect effects too, with many Chinese companies postponing capex investments. This will hit profits at both US and Chinese firms.
A longer-term impact is that China is being forced to develop its own semi-conductor industry, with companies such as Tencent already starting to develop chips for AI. As China catches up with the US, this could impact earnings of US semi-conductor companies in the mid-to-long term.
In short, any truce between US and China would definitely be positive for tech stocks.
Another important driver is economic growth. In the case of recession and deceleration of IT earnings growth, tech stocks will be among the first to suffer as investors switch to defensive assets. However, our baseline is that 2019 will not be a year of recession.
The third main driver – which is also the long-term driver of technology growth - is the market rollout of innovative technology.

Which technologies will bear most fruit?

We anticipate a step forward in the internet of things, while 5G (the fifth generation of cellular mobile communication, that targets lower energy consumption, reduced latency, massive device connectivity and a higher data rate), should also start to be rolled out in 2019. Currently, 5G is in test phase by a few operators, but this will evolve as the technology is more widely rolled out.
We are also carefully watching the evolution of autonomous driving and of electric vehicles. The growth of electric and autonomous vehicles will be accompanied by parallel growth in the semi-conductors on which they depend.
We feel slightly less comfortable about social media, which has not adequately responded to criticism over privacy and manipulation. Even if, potentially, there is significant upside in many of these names after the correction, growth in social media could be hampered by future regulation and litigation.

FAANGs cease to be key drivers of value

We should note that business models of the FAANGs are starting to mature and we see deceleration in their top line growth. Until now Alphabet (Google) has grown at 20% a year and Facebook at an incredible 45% a year. But in a clear sign of decelerating growth, Facebook is predicted to expand by 35% in 2018 and by 25% in 2019.
While the FAANGs will still be important in 2019, we no longer view them as key drivers of the industry’s evolution.

As a final word, we remain convinced that IT remains an attractive investment opportunity, as the industry will continue to be driven by the accelerating roll-out of world-changing new applications such as Internet of Things, advanced robotics, 5G and OLED. As an investor, you should monitor closely the evolution of the tariff war, global economic growth and the regulation of social media, factors that will probably have the biggest short-term impact on the sector.