Surfing on the technology wave

Technology companies pervade everyday life and dominate the equity markets more than ever these days. The coronavirus crisis has given technological megatrends like digital transformation and cloud computing a further boost. The technology sector promises a continuation of above-average growth and interesting investment opportunities in the years ahead. Here, a high return does not necessarily also entail high risk because many tech business models these days are largely immune to economic cycles. However, as is so often the case, it is crucial to pick the right stocks.


The FANMAG companies have become an essential part of everyday life

Online shopping on Amazon, navigating using Google Maps and meeting friends on Facebook – all of these activities in recent years have become as routine as brushing your teeth. The internet giants accompany us in daily life without us even noticing. But Facebook, Amazon, Netflix, Microsoft, Apple and Google (through its parent company Alphabet), which are collectively known under the acronym FANMAG, are definitely conspicuous on the stock market. After years of inexorable share-price gains, the market capitalizations of the FANMAGs have become so enormous that they together now make up more than 20% of the market cap of S&P 500 index of the 500 largest publicly traded US companies. These six stocks alone have a whopping combined weight of around 50% in the USA’s Nasdaq 100 technology index.


An imposing acronym
Tech stocks dominate US equity indices

Market capitalization of FANMAG* stocks relative to S&P 500 index

*FANMAG = Facebook, Amazon, Netflix, Microsoft, Apple, Google (Alphabet)

Source: Bloomberg, Kaiser Partner Privatbank


Everything from home during the pandemic
The FANMAG stocks are a reflection of the unstoppable digital transformation trend, which has gotten a further boost from the coronavirus crisis. Practically overnight, home offices became the new workplace for many employees and videoconferencing with Microsoft Teams or Zoom became a new custom, to cite a couple of examples. Even signing documents from different remote workplaces was not a problem – the cloud makes it possible. And even if the premiere of the newest blockbuster film fell victim to the pandemic, entertainment nonetheless could still be streamed from Netflix to home theaters or from Spotify concerts to stereos.

In the aftermath of the coronavirus pandemic, “nothing will be the same as before!” This frequent assertion in times of crisis will again probably not prove true this time. But the public health crisis does at least look destined to act as a lasting accelerant for technological megatrends like digitalization and cloud computing because even if our daily lives soon gradually return to normal, corporations and consumers will probably (want to) retain at least some of the new “customs”. For companies, this makes plenty of sense also from a business economics perspective because switching to digital channels can save office space (and rent costs) and travel expenses, and can reduce other types of operating costs.


Crisis? What crisis?
Growth (practically) immune to economic cycles

Worldwide market for cloud computing services, in USD billion

Source: Gartner, Kaiser Partner Privatbank


Sound fundamentals
The divergence between the new economy and the old economy has seldom been felt as acutely as in recent weeks. Whereas airline companies, for instance, have been struggling to survive in the face of the pandemic, various segments of the technology industry have registered unprecedented jumps in revenue. But even tech companies with somewhat less disruptive business concepts have gotten through the crisis in comparatively better shape because many of today’s business models in the technology sector are largely crisis-resistant and immune to economic cycles. Software and cloud services, for example, are generally purchased on subscription and bring in regularly recurring revenue (and earnings).

The technology sector has already shaken off the coronavirus crisis also with regard to its stock-market performance, with the Nasdaq index reascending to a new all-time high already in June, marking a resumption of the tech rally that has been underway for more than 11 years now. A look at the fundamentals shows the tech rally resting on a solid foundation. The share-price upswing over the past decade has been constantly underpinned by robust revenue growth, high profit margins and accordingly buoyant corporate earnings. That’s the reason why despite the meteoric share-price gains in some instances, tech stock valuations today are not necessarily (overly) expensive and are in no way comparable to the bubble-like overvaluations that triggered a years-long bear market in the technology sector at the turn of the millennium. There is indeed a small valuation premium relative to the broad market, but it appears justified given the technology sector’s above-average growth and high profitability. Disregarding inevitable temporary corrections, the fundamentals and the sector outlook taken together portend further upside potential for technology stocks in the years ahead.


Built on solid bedrock
High earnings growth justifies high stock prices

Earnings growth: S&P 500 IT index vs. S&P 500 index


Source: Bloomberg, Kaiser Partner Privatbank


China’s answer to Silicon Valley

Eyes, however, shouldn’t be directed solely toward Silicon Valley, because even though US companies dominate the technology sector in our neck of the woods, there are also some interesting players in Europe, Japan and South Korea. The toughest competition to the FANMAG companies, though, comes from China. In recent years the Middle Kingdom has brought forth internet giants like Alibaba (e-commerce) and Tencent (social media), which in the meantime have also made a name for themselves in the Western world.

They have grown in a domestic market that by far eclipses even the biggest Western market, the USA. Although only around 60% of the people in China have access to the internet, the Chinese market, with its more than 800 million web users, is roughly three times larger than the US market. And mobile internet usage in China is much more widespread than in Western countries and is really the standard there, so to speak. Mobile payment usage is one striking example of this: over 40% of Chinese consumers (583 million users) use their smartphones today to make payments, compared to only around one in five users in the USA (62 million). And the growth of the Chinese internet market continues to significantly outpace growth rates in industrialized countries. A further boost is now expected to come from the rollout of the 5G mobile telecommunication network, which the government of China is expediting.


A mammoth market…
…with further growth potential

Internet usage comparison: USA vs. China

Source: South China Morning Post, Kaiser Partner Privatbank


Western companies can also take a page from the Chinese in the area of innovative spirit. WeChat and Alipay, for example, have developed into veritable “super apps” that can be used to do anything imaginable – from shopping and booking taxis and flights to making money transactions – in a single portal. New business models can quickly be added to these apps, giving each one access to a pool of more than a billion users worldwide. This model has proven so successful that now even Facebook is copying it. The mobile internet is thus an area where the USA can learn something from China for a change. However, access to the gigantic closed-off market of Chinese consumers is likely to remain largely barred to Western companies.

So, whoever wishes to invest worldwide in the technological megatrends of the next few years cannot get around investing in Chinese companies. They have established themselves in the meantime as competitors to be taken seriously, particularly in the area of digital platforms. There is already even a Chinese counterpart to FANMAG: BAT (Baidu, Alibaba, Tencent). Our Disruptive Technologies stock basket combines the best of both technology worlds: it invests in the market leaders from Silicon Valley and in standout American niche players operating in the most promising segments of the technology industry, as well as in fast-growing champions from China.


Not solely made in the USA
A global megatrend

MSCI World IT index vs. MSCI World index

Source: Bloomberg, Kaiser Partner Privatbank


Oliver Hackel, CFA Senior Investment Strategist

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