At Canada Life Investments, we have long been bearish on a number of the US technology stocks on valuation grounds. Companies such as Alphabet (Google’s parent company), Amazon and Facebook are investor favourites and amongst the largest 10 stocks in the US equity market. Despite our valuation concerns, they have continued to deliver standout returns in recent years, even when the broader equity market struggled. This was particularly the case in 2017, when they were responsible for a significant chunk of the Index’s total return. However, they have struggled since March.
Not because of the economy (or bond yields)
This has not been down to a slowdown in the economy. Gross Domestic Product (GDP) growth remains robust in the US, whilst PMI’s remain at near record levels. It has not even been the result of higher bond yields. The 10 year US treasury yield has risen from 2.41% at the start of January to 2.78% today (as at 04/04/18). Typically, stocks trading at high multiples have high expectations embedded into their share prices and so are much more sensitive to negative newsflow. This is even more evident when bond yields are rising, given the present value of future earnings are also compressed.
However, this had little impact on stocks like Alphabet, Amazon and Facebook, such was there popularity in the market. As a result, they continued to build on 2017’s gains throughout January and February, as well as beating consensus earnings. Although we did not believe that these earnings justified trailing P/E ratios of 29x (Facebook), 56x (Alphabet) and 225x (Amazon) respectively, it did highlight their success was somewhat warranted. However, trouble was just around the corner.
A new era for tech?
Alphabet, Amazon and Facebook have all fallen more than -10% since the middle of March, as they have been hit by a succession of issues. First was a potential privacy breach of Facebook users by data analytics firm Cambridge Analytica, which was linked to Trump’s victory in the US. Alphabet has suffered from concerns that the European Union’s (EU) Competition Commission is looking at whether it should split up its various businesses. Meanwhile, Amazon is in the crosshairs of President Trump, who is accusing the business of profiting at the expense of the US Postal Service, plus there is a threat of an EU sales tax.
All of this points to the potential of a new era for tech businesses in the US, following years of outperformance and astonishing valuations. Although many of these stocks are well run companies, we believe valuations and sentiment have been driven to extremes, whilst the rest of the market has been left behind. This can be illustrated by the ever-growing proportion of the S&P 500 Index that is made up by technology companies.
Technology as a % of the S&P 500
Source: Morningstar Direct, as at 31/03/18.
Technology now represents nearly a quarter of the Index. We do not believe it can keep going up in such a way forever and, whilst timing the exact top is nigh on impossible, we remain confident that our more diversified, value-orientated portfolio is well-positioned for 2018 and beyond. As a result, the LF Canlife Global Equity Fund has retained its significant underweight in US technology stocks, instead preferring to invest in more contrarian names.
Source: Morningstar Direct & Canada Life Investments research, April 2018.
Past performance is not a guide to future performance. The value of investments may fall as well as rise and investors may not get back the amount invested. Income from investments may fluctuate. Currency fluctuations can also affect performance.
The information contained in this document is provided for use by investment professionals and is not for onward distribution to, or to be relied upon by, retail investors. No guarantee, warranty or representation (express or implied) is given as to the document’s accuracy or completeness. The views expressed in this document are those of the fund manager at the time of publication and should not be taken as advice, a forecast or a recommendation to buy or sell securities. These views are subject to change at any time without notice. This document is issued for information only by Canada Life Investments. This document does not constitute a direct offer to anyone, or a solicitation by anyone, to subscribe for shares or buy units in fund(s). Subscription for shares and buying units in the fund(s) must only be made on the basis of the latest Prospectus and the Key Investor Information Document (KIID) available at www.canadalifeinvestments.com. Some Canada Life Investments funds may invest in property funds that may be illiquid and subject to wide price spreads, both of which can impact the value of the fund. The value of the property is based on the opinion of a valuer and is therefore subjective.
Data Source – © 2018 Morningstar, Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information.
The Canada Life Investments blog page features images licensed from Getty Images International. These images shall not be downloaded, republished, retransmitted, reproduced or otherwise used in any way. Aside from the above, and unless otherwise stated, Canada Life retains copyright in and/or has a right to use all contents of this website (including text and graphics) and such contents shall not be copied, distributed, extracted or modified without the express prior written consent of Canada Life unless for private, non-commercial use.
CLI01153 Expiry 4 April 2019