In 1999, the Nasdaq returned a scorching 85.6%, the highest single-year return of any major US equit...
In 1999, the Nasdaq returned a scorching 85.6%, the highest single-year return of any major US equity index in history. The technology sector alone contributed a whopping 65.2% of the year's return for the S&P 500 Index.
Here's something you probably don't know: technology stocks are not uniformly growth-oriented and, as such, they should not all be viewed as having a similar risk/reward profile. In fact, the returns on technology stocks were almost perfectly correlated with the Morgan Stanley Cyclical Index for the first eight years of the 1990s. Since then, however, this correlation has clearly broken down, a development whose implications for portfolio managers and other investors could be significant.
Growth companies are those whose earnings are projected to grow at a faster pace than that of the market as a whole. This should occur regardless of the overall macroeconomic climate, implying that growth companies' earnings should be able to rise at a fairly stable, predictable rate. As a result, investors are typically willing to pay a premium via a higher valuation for the shares of such companies.
The value school of thought favours companies whose shares are selling at prices that are lower than the company is believed to be worth. Value-oriented industries tend to be 'cyclical' in nature, namely sensitive to changes in the economic cycle. As I see it, investors will realise that certain tech subsectors (semiconductors and computer hardware) are fundamentally closer to a value orientation than one of growth. A possible catalyst for this realisation in the near term is the US Federal Reserve, which appears likely to raise US short-term interest rates to stem inflationary pressures and slow the economy.
An environment of higher rates and slower economic activity, in turn, would undoubtedly hurt the prospects for more cyclical, value-oriented companies. Should the Fed raise rates at its next few monetary policy meetings, therefore, the shares of cyclical tech companies could falter - and possibly take many other tech stocks down with them - as the market's perception of their sensitivity to the economic cycle finally catches up with their valuations.
In the Credit Suisse Transatlantic Fund, I have anticipated this potential scenario by emphasising the shares of companies with a few important characteristics. These include stable US demand for their products/services; high proprietary content (in terms of brand power or technological edge) in their products/services; and exposure to growth in non-US markets.
As for technology, the concerns I have noted have not prevented me from finding several highly attractive opportunities. My research has particularly identified software developers that offer a high value-added component and whose sales are less dependent on the economy's overall condition than, say, semiconductor manufacturers, to which we have recently reduced exposure.
James Abate is portfolio manager at Credit Suisse Asset Management in New York
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