Does the run in US big tech make sense? From the winter lows, the rebound in the biggest technology stocks has seen several stocks double, and the ratings of Amazon, Nvidia and Tesla move to stratospheric levels. Not all of this can be put down to the magic of generative AI. But it does challenge fundamental investment analysis and active managers. Remarkably, the fashion for expensive growth comes at a time when global growth is challenged and the pace of innovation is questioned. Behavioural finance has taught us more about bubbles, but not stopped them. Certainly, amidst dull global growth, businesses with moats look like a good hiding place. But against a background of higher ten-year bond yields, tech performance is surprising. In the 12 months prior to last October, the correlation between tech performance and the adverse impact of rising yields was as expected. The last nine months have been unusual. Even if US inflation and yields have peaked, there must be a risk of a snap-back.
The disconnect in tech valuation is underlined by the dearth of IPOs. New US listings are running at their lowest level in two decades. And the slower pace of innovation is shown by developments such as Meta’s new platform, Threads, apparently targeted at the ailing Twitter. It may take time to build a role for Threads, but it seems just derivative. Is this really the best that a supposedly dominant tech giant can offer? The rally in many technology names can be traced to the headline coverage of ChatGPT, which sprinkled pixie dust across the sector. Rather than AI propelling new winners and IPOs, investors have projected their hopes and dreams onto established businesses such as Nvidia, Microsoft and Tesla. AI may improve the world’s productivity, but it is far from clear that equity investors will directly benefit. The challenge is to retain proprietary control of IP – cost savings may simply be competed away. Weaker technology innovation is also showing up clearly in the fintech world, where valuations are softening, cash is drying up and the winning ideas now mainly focus on the infrastructure and plumbing of finance.
The rising tide has lifted all – from Bitcoin to ARK Innovation. With the exception of Microsoft and Nvidia the tech giants are not making new all-time highs. It looks more like an oversold rally from the sell-off after the pandemic enthusiasm had faded. A weaker US Dollar has flattered international earnings for US companies and given a tailwind. Yet, faced with a lack of new applications and increasing regulation on data use, how far out should earnings be valued? Size and cashflow do not make a business unassailable. The rush into tech looks emotional, with asset allocators, passive investing and momentum all playing a part. Usually with an uncertain outlook and the tightening cycle still underway, US Treasuries would look like a safe haven. It seems that role is currently being played by the big tech stocks, with investors unnerved by the Fed. If confidence returns to Treasuries on the back of lower inflation, money could move from tech.
Worryingly, this decline in US market breadth suggests diminishing overall confidence. Value creation is concentrated in a handful of stocks and Apple and Microsoft have dominant positions within the overall S&P market cap. Excluding peaks such as the tech bubble, the S&P is at its highest valuation for decades. Fortunately, this narrowing of interest is still largely a US phenomenon, less pronounced in other markets. New technology is exciting and projects a lot of emotion onto stocks. But the lack of new highs suggests the tech sector is not yet in bubble territory. However, market behaviour for the year to date does look a lot like herding and momentum.