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The writer is global chief investment strategist for the BlackRock Investment Institute
More time spent online during global lockdowns proved to be a figurative shot in the arm for technology companies over the past 12 months.
With actual shots now protecting people from Covid-19, companies with more to gain from the economic restart are increasingly in favour with investors and tech stocks have seen their fair share of volatility in recent months. Despite this, we believe there are good reasons to stay invested.
Some fear that higher near-term inflation may force central banks to raise policy rates and that this could hit tech stocks with high growth expectations.
The thinking goes that higher rates would reduce the present value of long-dated cash flows. But our view is that this fear stems from a misunderstanding of the US Federal Reserve’s new policy framework, adopted in August, which would lead to it letting inflation run hot to make up for past misses.
The framework suggests the lift-off from zero rates will be later than markets expect, and argues for looking through near-term volatility.
We had expected demand would run ahead of supply in the first phase of the restart, pushing inflation higher. The pandemic has disrupted supply chains and created a well of pent-up demand. Ultimately, however, this supply shortfall should come back online.
That said, markets are still underappreciating medium-term price pressures that could result from higher production costs post-pandemic, the Fed’s new policy framework and debt serviceability considerations from higher public debt levels. This implies higher than expected inflation in the second half of this decade.
For the next six to 12 months, our moderately positive view on equities, including tech, is predicated on a conviction that the Fed is far more committed to its new framework than many believe. At times, markets have shown scepticism about this as the economy has roared back to life. Current market pricing and consensus expectations suggest that the federal funds rate — the Fed’s policy rate — will start rising sooner than both the central bank’s projections and our own expectations.
As well as underestimating the Fed’s commitment, parts of the markets may be over-extrapolating from the near-term growth pop. The coronavirus shock can be thought of as more akin to a natural disaster, followed by a rapid and unique “restart”, rather than a traditional business cycle recession followed by a “recovery”. That lends weight to our view that the near-term growth spurt will be transitory and erratic.
Beyond these singular dynamics, tech companies were performing strongly even before the pandemic took hold: no sector in the MSCI World index has had better earnings over the past five years. Looking ahead, long-term trends including digitalisation and a “green” energy transition to a low-carbon economy are supportive. The pandemic has only accelerated these secular trends.
The sector’s diversity is also relevant. It is important to recognise the IT sector as defined by the GICS industry classification system for markets covers software and services, tech hardware and equipment, and semiconductors and equipment. However, it does not cover online search and ecommerce giants, which we would also look to include in any wider discussion of the tech sector.
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Taking a more nuanced perspective, we can see that a shift into cyclical stocks may hurt some tech companies that have gained from the increase in remote working and other pandemic-related trends. But it could boost more cyclical tech industries, such as semiconductors.
While supply chain disruptions and strategic US-China competition may cause more volatility, semiconductor companies benefit from strong pricing power. And some of the excess savings built up over the past year are likely to find their way to consumer electronics, giving chip companies further support.
Even the narrative of “rate up, tech down” is too simple. For any given rise in the benchmark 10-year Treasury yield, the type of tech company under consideration matters. The rate sensitivity for equity valuations is greater for the highest-growth, least-profitable companies.
By this logic, bigger tech names — notwithstanding the risk of regulatory break-up and forthcoming US corporate tax reforms — could be more resilient. The implication is that, with the secular investment case for tech intact, investors would do well to look through near-term volatility in markets and stay the course.
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