Bill Blain wonders whether it’s time to cash in some of those tech gains, in preparation for the next phase of the cycle.
2020 and will go down as one of the strangest years ever in financial markets. The pandemic triggered a global shock and depression unlike anything we’ve ever seen or experienced before. Global supply chains sagged and snapped. Whole sectors of the connected economy have been shuttered and remain sub-optimal. More jobs were lost faster than ever before. Governments were forced to step in with massive support and bailout packages. No one know just how long we have to maintain shutdown to avoid a medical overload crisis, nor how likely, or when, a vaccine may correct the situation.
In short, the global economy took a massive hit. Although it is now stabilising, it remains vulnerable to rising debts, further job losses, renewed lockdown and crashing sentiment.
Yes, despite the pandemic crisis, Global stocks markets have surprised to the upside. Since the virus hit in March, the main indices have recovered strongly, apparently disconnected from the unfolding economic catastrophe around us. But analyse the underlying individual stocks, and its soon clear the gains have been heavily focused on a relatively small number of Tech Stocks, particularly the biggest familiar names. Dig a little deeper and it soon becomes apparent the reasons for gains differ and vary across the many different firms that make up the tech multiverse.
Recently a number of investment banks have called for shifts in investment direction – out of overpriced Tech stocks, and into “fundamental value” stocks which remain cheap ahead of any coronavirus resolution. Fundamental stocks are those which do dull, boring, predictable stuff, making profits and paying dividends by doing stuff they’ve been doing for years.
To understand who the likely winners and losers are likely to be, it’s critical to understand the reasons tech has done so well, and why the optimism of further upside might be fading.
The first thing to understand is why have stocks done so well? It’s not because companies and industries are doing particularly well making and selling more stuff and therefore earning greater profits, but because equities look a better investment relative to other financial assets. That’s because interest rates are so low, they make any other financial asset look more attractive in terms of higher dividend yields. That means investors are piling into stock markets and pushing up prices. As a result, price/earnings ratios look abnormally high and frothy.
The second thing to consider is why have new tech stocks performed so well relative to other stocks? New disruptive companies that undermine or replace established products and show the potential to create completely new additional value streams are always going to attract investment. They are literally new wealth!
Back in March/April the whole world was trying to guess just how quickly the global economy would bounce back from the initial pandemic. The question was just how steep the v-shaped recovery we all imagined in March and April would be. People assumed tech revenues would continue to rise.
As expectations of a v-shape recovery faded through the summer, the tech narrative changed. It morphed into expectations that new products and tech – for instance cloud-based services to support home working, new PCs and firms like Zoom – would see an acceleration in how quickly their new tech products would be adopted.
It’s only now that the market is stopping to take a breath, realising that some of these expectations aren’t playing out as the pandemic narrative shifts again, back towards renewed lockdowns. As a result, it’s time to refocus on the fundamentals of tech.
And that’s an issue of shifting expectations and competition.
Let’s start with the Streaming Wars. Netflix did very well in the initial crisis stages. Every investor realised people forced to stay home will watch more TV. Yet, in the summer I suggested Netflix would be the stock to drop. Competition is the critical issue. There are already more streaming services than you can point a sharp, pointy stick at…
Netflix is already the clear streaming leader with 32% of total stream time viewing. It produces plenty of its own fantastic content and has rights on plenty of other stuff that people want to see. However, the market is already maturing. Disney’s streaming services get a respectable 16% of streamtime, but Mouse Co has the advantage of a great stable of entertainment classics plus the Marvel, and Star War franchises. It’s already spending more on content creation than Netflix. In less than one year Disney+ has attracted 60 million subs, attracting far more new customers than the rest of the streamverse combined.
Streaming is going to be an area for content aggregators and providers of specialised viewing. Being the age I am I recently signed up for Britbox – I still haven’t seen the final episode of Blakes 7 so I still have no idea what the classic UK cheap-as-chips space opera was all about, and apparently every episode of UFO and Space 1999 is on it! Because I am a registered Apple addict, I have Apple TV, but there frankly isn’t much to watch… yet.
Netflix is making money – but it missed expected Q3 subscriber number growth by 33% and EPS were well below estimates. It may continue to grow, but some of the magic has gone – just like it did for Blockbuster video stores when Netflix first demonstrated how streaming could work. If you are a holder, Netflix’s stock made decent gains this troubled year. Maybe it’s time to put money in the bank?
Moreover, Disney has just announced a refocus to spend more on creating new content for its streaming businesses. It didn’t have much choice. Coronavirus has slaughtered its parks business (down 83% from $6.6 billion in Q3 2019) and new film business (down 55% since this time last year). What’s spectacular is Mouse Corp has responded fast to the challenge. The virus has shaken Disney awake. Creation, distribution and monetisation of content is its future.
There is an interesting lesson in Streaming: how an old incumbent entertainment business is proving it can weather, innovate and prosper even when new disruptive technologies change the narrative. The risk for the other streamers, including Netflix, is that their tech premium reduces as competition rises and their lack of profitability dooms them to also ran status.
Something similar is happening in the new electric vehicles (EV) sector, in terms of new and old competition.
According to Elon Musk’s fanboys, everyone knows Tesla will soon be making 100% of all the cars in the world, and that won’t even be its main business – which will be saving the world through its battery business, reinventing autonomous driving etc. Sarcasm Alert: It won’t.
There have been over 150 new EV launches this year. Other firms have already got 400-mile electric pickups on the road. All the major German automakers are moving vigorously into the market with new tech and new models. The Chinese are outselling Tesla. The first hydrogen vehicles are for sale. Hybrids are gaining greater traction.
EVs were disruptive. Now they are mainstream. Competition will pull down margins and increase the cost of lithium for batteries. If I were Tesla, I’d be wondering how to deliver all these promises about cheaper and more cars while the market changes and shifts against its first-mover status.
Tesla’s stock gains this year were incredible. It is worth more than any other producer – and hasn’t yet made a penny selling cars (it’s made profit selling regulatory credits). Toyota makes 40 times more cars than Tesla and sells every single one at a profit. Maybe it’s time to put some of Tesla’s extraordinary, retail fuelled market cap in the bank?
For Apple, the problem is different. It’s under little competitive threat – it’s created its own environment of Apple addicts who will snap up product upgrades as soon as they are launched. It’s become the most valuable stock on the planet on the back of its marketing prowess. Everyone wants its bright shinny things. It’s very difficult to convince an Apple addict an iPhone does exactly what every other cheaper phone does.
How long before cold turkey? Or when do Appleholics realise they’ve been upgrading the same stuff for decades and Apple hasn’t produced anything unique or new in years… since Steve? Perhaps it’s also time to put some of the gains from the world’s most valuable firm in the bank?
And then there is Regulation: Amazon, Facebook, Apple and Google are in the political crosshairs for “anti-competitive, monopolist behaviours”, and are likely to suffer from new anti-trust regulations. Google will be lucky to retain its favoured rate-setting go-to browser status. And there is the issue of surveillance capitalism and how certain tech firms have utilised Algorithms to monetise us – which looks, smells, and feels just like subliminal advertising, which was banned in the 1960s.
On top of the regulatory issues is tax. Thus far the Tech giants have avoided paying anywhere close to their full share. Nations around the globe look unable to agree on how to tax the tech multinationals who charge in one country, bill in another, and deliver to a third.
The moment government works out how to tax and regulate anything… is the moment to sell. As I’ve hinted, are the rising tax/regulatory risks to tech reasons to cash in yet more chips?
And what would you then do with the money you just pulled out the tech market? Well, that’s a question for another day…