What could happen to tech stocks if it all goes wrong (and history repeats itself?)
As this column pointed out last week, six of the world’s seven biggest companies by market capitalisation hail from the technology sector, which also offers 10 of the most valuable 25 companies.
The world’s 25 biggest companies by market capitalisation
Advisers and clients with exposure to this sector, either directly via technology-dedicated funds or indirectly via markets which have a heavy weighting in tech, such as the USA or Asia, may see this as a reassuring vindication of their faith.
Others may be less sanguine, in the view that these stocks’ very size means that they are implicitly the most popular stocks with advisers and clients right now – for this will remind many of investment legend Warren Buffett’s warning that: “You can’t buy what is popular and do well.”
The wisdom of Buffett’s words is supported by looking at two prior episodes when one or two sectors were particularly popular and were driving stock markets higher – and any adviser or client who bought into them when they were at the absolute height of their popularity, at the market peaks in 1999 and 2007, would have suffered some serious portfolio pain.
Any adviser and client who were partying like it was 1999 as the tech, media and telecoms bubble took off will have enjoyed themselves, but only if they got out when everyone else was piling in.
- On 31 December 1999, no fewer than 15 of the world’s 25 biggest companies hailed from the technology, media and telecoms sectors. Buying all 25, in the view that what was working then would keep working, would have inflicted losses on the investor over one, three, five and ten years as well as to date.
- Buying only the hottest stocks of all – the TMT names – would have made the losses even worse.
- In total just nine of the 25 have yielded capital gains for investors since the 1999 peak and only four – Microsoft, Intel, IBM and Oracle – are TMT companies. One – WorldCom – even went spectacularly bust.
Buying the 25 biggest stocks at the 1999 peak would have lead to hefty portfolio losses, even to this day
Source: Bloomberg, Thomson Reuters Datastream. *(From 31 December 1999. **To 11 April 2018).
The most popular stocks and sectors may have changed by 2007 but advisers and clients who piled in to the world’s 25 biggest stocks by market value that summer came similarly unstuck.
- This time, it was energy stocks and financial services firms, especially banks, who dominated the leaderboard, helped by a surge in oil to $147 a barrel and booms in the US housing and global financial markets.
- Anyone buying all 25 names at the July 2007 high would have just about got their money back in capital terms, even if only nine of the stocks have since generated a positive return – and only three of those hail from the list of 12 energy and financial stocks which dominated the market cap rankings just over a decade ago.
Buying the 25 biggest stocks at the 2007 peak would mean investors and clients have just about got their money back
Source: Bloomberg, Thomson Reuters Datastream. *(From 19 July 2007. **To 11 April 2018).
There are four lessons which advisers and clients can draw from this data:
- Do not assume that what is working well now will always work in the future. New rivals, new technologies and simple management incompetence (a change in strategy, a bad acquisition) can quickly unseat even the most successful company.
- Do make sure that the appointed fund managers are paying attention to a company’s balance sheet and cash flow, and not just its profit and loss account and share price momentum. Those tech firms which managed to survive the 2000-03 TMT bust and even thrive generally had strong balance sheets laden with cash. As a result, Microsoft has been able to reinvent itself and Intel has maintained its technological and scale edge in microprocessor production, for example. The losers included the highly acquisitive and highly-indebted WorldCom, which turned into an accounting fraud, and Alcatel, whose defensive merger with American rival Lucent merely added complexity to an already difficult situation.
- Valuation matters. No matter how good the story looks, advisers and clients need to make sure that they are paying a reasonable valuation which leaves room for upside but also protects the downside if and when something goes wrong.
- It is hard to buy what is popular and do well for any sustained period of time. This is not to say that technology stocks, or markets in general, are about to implode. But it does hark back to Buffett’s aversion to buying what is popular and his preference for buying securities when no-one is interested, rather than when everyone is. And while it is tempting to think that we can time markets and get out before anyone else does, the chances of this are in reality probably slim. On that point, we can again turn to Buffett who once wrote:
“We have a lot of fun as the bubble blows up and we all think we are going to get out at five minutes before midnight – but there are no clocks on the wall.”