After a stellar 2017 for Big Tech, fears are rising that a slump in the FANG stocks – Facebook, Amazon, Netflix and Google – could cause a market correction in 2018. How will growing regulatory pressures and tax reforms impact the FANGs this year? We asked fund managers whether tech is up for a reboot.
View from US equity expert
Matthew Benkendorf - Vontobel Asset Management
We are always concerned about the possibility of a general sell-off in the markets, rather than an isolated event in one sector. Corrections are difficult to predict and could be caused by an unforeseen destabilizing political event, weak economic data or a surprise in the interest rate environment.
In our view, the technology sector is not facing a disproportionately greater risk of a correction than other areas of the market. Absent a destabilizing event, we think earnings growth should continue to be strong in the tech space and a correction is unlikely. Valuations are not particularly high, especially if tech companies can continue to deliver sustainable earnings growth. We think regulatory pressures will continue to be an overhang, but they don’t present any material risks to the earnings of the FANG companies. In Europe, regulators are more or less fighting yesterday’s battles.
Tech companies have largely evolved beyond the remediation measures that the regulators are considering. Fines have typically been immaterial given the size of the companies. In the US, we think investors will continue to focus on regulation. Tech companies have been aware of the issues they are facing and are working faster than the regulators to remedy them.
For example, Facebook is taking steps to move past the advertising and election interference issues. If there is a sell-off in the technology sector, it will impact a lot of investors because ownership levels in technology have been quite high over the past few years. But in the near term, we don’t foresee any issues that could disrupt the business models or the growth trajectories of tech companies. We are comfortable with our larger tech investments – companies such as Alphabet, Facebook, Visa and Mastercard.
However, the broader risk we are focusing on is the possibility that a correction in the tech market could have a far-reaching effect on the earnings growth and business models of the various industries and sectors that are being disrupted by technology.
View from global tech expert
Brad Slingerlend - Janus Henderson
Last year was a vintage one for technology stocks, with the S&P Information Technology sector returning 37% compared with 19% for the main index. That outperformance has led some to predict that a correction may be on the cards in 2018.
However, arguments suggesting that a reduction in US corporate taxes will be a headwind for the sector tend to miss certain nuances that indicate tech stocks can continue to climb. For a start, the sharp rises in valuations for Amazon, Google’s parent Alphabet, Facebook and Apple – whose shares all climbed by more than 36% last year – were largely merited on the basis of fundamental business performance, rather than investor euphoria.
While the tech sector’s US corporate tax rate may not decline much in these reforms, incentives for increasing capital expenditures will create opportunities. Cash repatriation also means that M&A activity is likely to increase, boosting both small and large companies.
Perhaps the biggest mistake would be to invest passively. This limits the upside potential from innovative, high-growth names by giving too much exposure to legacy companies such as IBM, SAP, Cisco and Oracle. Passive investors are betting on yesterday’s winners, not tomorrow’s.
Apple had a rousing 2017 on the back of the 10th anniversary of the iPhone, climbing 46%, but may underperform this year because another significant product launch won’t come for 18 months or so. Facebook may also struggle to match or exceed its 53% advance from last year because of the changes it has made to its news feed in a bid to appease regulators.
Conversely, Amazon and Alphabet seem poised to enjoy another good year on the back of growth in their cloud businesses and e-commerce, which may get a boost from the rollout of 5G mobile technology. These innovations aren’t available to passive investors.
While all the tech mega caps performed strongly in 2017, this year is likely to bring a mix of winners and losers. Even so, we foresee growth over the next decade, driven by accelerating fundamentals and developments such as AI, cloud computing, 5G and the internet of things.
View from US tech expert
Greg Tuorto - JP Morgan Asset Management
We remain positive on technology into 2018 – that’s all tech, big and small. We think the fundamental case for continued revenue and earnings growth is as good as it has been for the past 20 years. We also feel many other sectors lack the catalyststechnology has and the froth that we have seen in previous cycles – driven by speculative dynamics, mergers and acquisitions or initial public offerings.
When it comes to the stocks themselves being the catalyst for a market correction, I think we have seen some attempts at that in the past few weeks. We had the tweet from President Trump about Amazon’s favorable shipping rates and then the change to the news feed at Facebook.
We have also seen a consistent upward trend in the technology space for the first two trading weeks of 2018, with the tech sector up another 5%. The stocks are by no means bulletproof, but we always look to how they react to bad or unexpected news.
In terms of the business models, I think the president’s tweet is just another reason why Amazon continues to insulate itself from third-party logistics players by building up its internal capabilities. The Facebook shift is one that could make a big difference to the firm’s revenue-generating capabilities, given that it has now gained a share of the advertising market.
Large profit pools are often targets for revenue-seeking regulatory bodies. We saw this with Microsoft a decade ago, and we know that these are not things to be ignored.
However, the ubiquity of companies such as Google, Facebook and Netflix in the life of the average consumer makes it less likely that you will have a grassroots groundswell of popular opinion against them. This does not entirely insulate them from scrutiny, but it does help to make them less of a target.
View from equity expert
Jeremy Gleeson - AXA IM Framlington Equities
This is not a new fear, I would suggest that we heard similar concerns in 2015, 2016 and 2017. Firstly, let’s look at the macro-economy. The global economic cycle remains strong. Annual global real GDP growth rose to its highest level for five years, and is now expected to rise further in 2018. Consumer income growth is supporting domestic demand, and recent tax reform in the US is leading to wage growth, which should further support consumption. There are no signs of overheating, and central bank policies are constructive.
This is being reflected in earnings, with the S&P 500 expected to have delivered 10% earnings growth in 2017, followed by an acceleration in earnings growth in 2018. Despite the view that the technology sector gets less of a benefit from lower domestic tax rates, the S&P 500 Information Technology (IT) sector is expected to deliver 29% earnings growth in 2018, following an estimation that it delivered 24% growth in 2017. Meanwhile, the IT sector trades on a forward multiple of 19.8x, a small premium to the broader index at 18.8x. The technology sector is a far cry from where it was in 2000, with companies today having proper earnings and positive cash flow.
With regards to regulatory pressure, this is probably the biggest unknown, as it’s always hard to predict which companies could suddenly come under increased scrutiny from government. These companies are offering products and services that consumers use and love, it would be a surprise to see regulation become a significant burden.
We believe that there are a number of drivers for growth for those companies benefitting from the transition to the digital economy. We would highlight four in particular.
Firstly, even though its feels like e-commerce has been around for a long time already, just 9% of global retail sales are conducted online. Secondly, global internet penetration continues to rise, and is expected to reach 66% in 2025, an increase of 50% in 10 years. Thirdly, much of this increase is driven by smartphone adoption, which is enabling consumers to make better informed purchase decisions, and conduct these purchases at a time convenient to them.
Lastly, we are reaching a tipping point for businesses to decide whether or not they wish to be part of the digital economy, and those that do will need help from a variety of technology companies that have expertise in data analytics, customer relationship management and digital payments, which pave the way for demand for new technology over the coming years.