What Tech Giveth, Tech Taketh Away

Friday Reflection | September 4, 2020

What Tech Giveth, Tech Taketh Away

Most of July and August saw the S&P 500 steadily moving higher, seemingly without material progress in the broad economy and the fight against the global pandemic. This week, that momentum hit an air pocket and prices swiftly declined. Overall, the S&P 500 index lost 2.3%, and was led downward by declines in major tech companies. Tesla and Apple saw some erosion of their dramatic gains, both losing more than 9% in the last two days. But, they are, nonetheless, still up 300% and 85% respectively since the end of March. These two companies and a small handful of other mega-cap tech stocks have been a primary driver for the current market recovery, and will continue to hold significant sway over the direction of the S&P 500.

Meanwhile, we are hearing increasing concerns about the looming election, and the prospects of delayed results or even the specter of power not transitioning peacefully. That is indeed a risk, just like many other risks that exist for investors committing capital to long-term investments in an attempt to build wealth and security for themselves and their family. We will talk more about the election in coming weeks, but our bottom line is a reinforced commitment to diversification – both between stocks and bonds, between US companies and international businesses, and between multiple potential outcomes. It is this diversification that supports our confidence that regardless of what part of the market is doing well, our clients reap some of the benefits, and remain resilient.

When media reports on “the market” they are usually referring to the price of the S&P 500. This major US stock index acts as a barometer for the overall landscape of investable companies, and is easily confused as a barometer for the entire economy. The S&P is weighted by each company’s market value which leads a small handful of companies with the highest values to drive most of the performance. When recent headlines tout that the market is going up every day and hitting record highs, it hasn’t been the entire S&P 500; it’s essentially seven large technology stocks – Facebook, Amazon, Apple, Microsoft, Netflix, Google, and Tesla. For example, the S&P 500 is up 6.1% so far in 2020 due to these stocks, but if we assign equal weight to all 500 companies rather than artificially overweighting tech stocks, the index is actually down -3.8%.

When the market declined this week, it was due to a downward move in the prices of these high-flying tech stocks. In the view of many investors this has been overdue, and represents a healthy move for a market that had gotten ahead of itself. Whether the tech selloff worsens in the coming days remains uncertain at this point. The tailwinds supporting this sector since March have not changed: ultralow interest rates that make future cash flows worth more today, a pandemic that gives an advantage to companies that don’t rely on in-person interactions for their sales, and a hunger for growth among investors during a recession. That said, current price is an important component of any investment decision.

Given the recent outperformance of these companies, the price tags are reminiscent of past moments of overzealous investment. The downside can be swift as we saw the past two days. While this may not be the bursting of the tech bubble 2.0, the disconnect between a single sector and the remainder of the market and broad economy is not sustainable over time.

The market has been led higher by a small cadre of beloved stocks before.  History shows us that not only has euphoria for a small group of companies existed in past moments, but these periods have occasionally lasted for extended periods of time before reverting to more reasonable levels.

One example is the “Nifty Fifty” from the early 1970s.  The name given to a group of fifty US blue-chip stocks which performed very strongly in the 1960s and early 1970s, becoming the darling stocks of that era. The companies, which included household names like McDonald’s, General Electric, and Polaroid, traded on very high valuations over many years[1].  Investors too often viewed these as “one-decision stocks”, meaning that you should buy them and never sell them.  We’ve heard similar refrains from investors in certain tech stocks in recent years. As more rational students of history, we know that nothing lasts forever.  Even these fifty household names had their day of reckoning, when beginning in January, 1973 the S&P 500 declined every month for 23 straight months.  A new sustained upward trend in stocks didn’t begin for another eight years after that.

Similar bubbles have occurred at other moments, from the dot-com bubble of the late 1990s all the way back to the Dutch tulip craze in the 1600s[2].  We’ve moved beyond the simpler days of trading tulip bulbs and ventured on to electric vehicle manufacturers and video conferencing stocks, but the human traits that lead to bubble formation and unchecked optimism still exist in ample supply.

Whether or not the blue-chip tech stocks can sustain the dramatic outperformance, we are increasingly mindful of allocation and concentration in our client portfolios. Even with diversified exposure, we are careful about adding further investment at today’s elevated prices, and are emphasizing the process of rebalancing portfolios to ensure we maintain our intended level of diversification.

Commitment to diversification makes it easier to handle the ongoing risk of the stock market, and helps avoid the temptation to exit the market at a painful moment. Once you are out of the market, you face the challenge of determining when it is safe to reinvest. Similar to the current experience of pandemic isolation, the longer we stay inside, the harder it is to know the ways in which the community is handling the risk of infection. Instead of withdrawing, we want to build a sustainable path to stay engaged in the market – putting on a “financial face mask” to feel more comfortable and improve resiliency, while still moving forward with your portfolio and your long-term plans.

[1] See the full Nifty Fifty list here: https://en.wikipedia.org/wiki/Nifty_Fifty

[2] https://www.investopedia.com/terms/d/dutch_tulip_bulb_market_bubble.asp