Overweight Tech Yet Finger Your Worry Beads
Technology, barring bubbles, can tick at 1.5 times S&P 500 Index valuation. With the market at 18 times earnings and just minimal earnings growth in sight, tech cries out to be overweighted in a setting of minimal GDP momentum.
Biggest prospective negative in tech, up to 22% of the S&P 500, is that the capital spending sector in GDP just turned negative. When spending kicks in, technology houses boom. If tech spending rolls over, there’s no bullish case.
Summer of 2001, Nasdaq rested in tatters, the economy stalled out. Democrats and Republicans were at odds on how to revive the country. (Sound familiar?) Capital spending fueled by the telecommunications sector and the internet hit a wall and wouldn’t recover for years. Internet enablers like Exodus cringed in the shadows darkening their headquarters. Cisco Systems sold in the mid-teens after hitting par mid-2000.
Nasdaq declined 60% over 12 months. Amazon crumbled by 80%. The penalty for announcing quarterly earnings below consensus rose from 10% to 30%. Today, we’re closer to the 10% haircut level. Grounds for reflection. Today, a handful of internet, tech and e-commerce stocks comprise 20% of the S&P 500 market’s capitalization, starting with Microsoft, now a trillion-dollar property with Apple and Amazon on its heels.
Tech can run twice as volatile as the market, both ways, up and down. You need conviction to buy, hold or sell such animals. Tech is the market, other sectors don’t match up. It outweighs industrials and financials, combined. Energy has paled into insignificance at 4.8%. Merck, Coca-Cola and Procter & Gamble no longer are big cheeses.
Some historical perspective: Summer of 2001, economists and the Street’s pundits debated whether the country would succumb to recession. The S&P 500 Index ticked near 1,200 with interest rates on Treasuries at 5.5%. They said the market could be 30% overvalued unless corporate earnings bounced back in 2002. (They did so!) Consider, the consensus on earnings had slid down steadily from $60 a share to $50, so the market stood at 20 times earnings.
I studied the cycle for information technology, normally a four-year span because hardware depreciation is a four to five-year life. The gut call was 2002 would be in recovery, following the 2001 wipeout. Timely, Alan Greenspan cut the discount rate and tech took off for a long upcycle. Stocks like Cisco, Intel and Oracle had dropped between 60% and 75% by yearend 2001 from ridiculous 2000 highs.
Never underestimate how low a piece of paper can sell at. In the financial meltdown of 2008-2009 Bank of America’s preferred, $25 par, sold at five bucks. Citigroup needed a reverse split to keep from trading like a ragamuffin. Boeing just sold billions of debentures A rated. Does anybody but me remember that Douglas Aircraft went out of business because its assembly line failed in productivity? The DC-9 was priced too low on order books. Was this in 1962?
Reasoning from historical perspective gets overdone, so I looked at price performance for a handful of big cap iconic pieces of paper, past five years. Surprises, surprises! First, consider the Big Board can be overshadowed by Nasdaq adjusted for trading volume. Nasdaq is no longer a side ring. Alibaba is not counted in the market cap of the S&P 500 Index, but is a $500 billion property overly sensitive to Trump flexing his muscles on China.
As a tech player, I’d disregard the construct of price-earnings ratios. You would never buy anything, otherwise. I use operating cash flow and free cash flow as defining metrics. It’s how I found my way into Facebook, even Microsoft and Alibaba. Amazon is a luxury, because you have no trusty metrics to hang your hat on. You conjure its 25% revenue growth someday delivers earnings per share. Jeff Bezos will keep you guessing till the end of time or until he needs earnings to appease the Street.
Feel entitled to one or two luxuries, but then it has to stop. After reviewing price performance past five years for iconic, household stocks, I found tech is not the only promised land for aggressive players. Coming out of the FRB-made recession of 1982, price to book value produced exceptional returns, but turned useless after the market’s recovery. Cash flow models superseded earnings models along with weighty share buyback schemata, a free-cash flow byproduct. A stock’s multiple of Ebitda became the signal desideratum for high-tech and internet paper.
When I checked five-year charts of several non-tech properties, I was surprised by several dynamic upward trajectories. Costco nearly doubled along with PepsiCo and Home Depot. Meanwhile, IBM’s numbers stood in negative ground and Pfizer was a minimal mover.
Walt Disney traded at $120 back in 2015, now just $143, a tough contentious sector proved a rollercoaster ride. JPMorgan Chase rose by 50% past five years. Meanwhile, Exxon Mobil traced a negative chart formation of declining tops, down from over par to $70. You can’t rely on the biggest and rationalize yourself into the poor house.
In tech, Microsoft tripled over five years. Facebook proved erratic but more than doubled. From 2015 through 2018, Amazon soared from $500 to hit $2,000. A great stock, but no serious earnings per share numbers.
Queer concepts periodically invade the investment world. The Street late fifties was captivated by paperback publishers, bowling pin setter makers and the compact-car producer American Motors. All this while McDonald’s, Walmart and IBM were shaping long-lasting footprints.
The enterprise value of U.S. Steel stands under $5 billion, which is where Facebook’s slap from the FTC came in. Day after the most widely expected FRB quarter pointer past 50 years, materials stocks like Alcoa and U.S. Steel shed a snappy 5%, and next day and additional 10%, along with oil operators like Halliburton. Alibaba, too, got caught in the tug-of-war between Trump and China as did major banks like Citigroup.
The market is saying we’re about to wallow like Europe and Japan: Hardly perceptible GDP growth, near zero inflation and near zero interest rates on short-term Treasuries. The Fed has no credible stimulus package at hand for such deflation.
The future still belongs to innovative tech houses which could end up as a 30% weighting in the S&P 500. All other sectors 10% or under.
Sosnoff and / or his managed accounts own: Microsoft, Bank of America, Citigroup, Alibaba, Facebook and JPMorgan Chase.