Tech Sector – The madness of crowds.

The sector’s “Semper Augustus” moment may not be far away.

• The current frenzy gripping the technology sector has nothing to do with the quality or fundamentals of the companies themselves but instead is being driven by sentiment and narratives which makes the technology sector both an inefficient and a dangerous place for value investors.
• (Semper Augustus was the rarest and most expensive tulip bulb during the tulip mania of the 17^th century and changed hands for a price greater than a house or large plot of land before collapsing in value).
• Every bubble is slightly different in terms of its drivers because if it were exactly the same, it would be instantly recognised as such and would therefore never be able to form.
• However, the end result is always the same which is a correction such that the price of the investments in question (South Sea Company shares, tulip bulbs or internet companies) falls back to levels that more accurately reflect the reality with which these assets are engaged.
• This bubble is different from the internet bubble of 1999 and 2000 as the companies that are involved are real companies and are unlikely to disappear like many of the internet start-ups did 20 years ago.
• There is real demand for their services and many of them will continue to exist following the correction but the hype, speculation and pure mania that is driving demand for their shares both in the market and at IPO is exactly the same.
• This has partly been driven by the Federal Reserve which continues to supress interest rates meaning that investors have been forced into the stock market, but it is really only into the technology sector that this money has been pumped.
• Other sectors such as travel, leisure, banking and energy have recovered very little meaning that all time highs on global indices have really been driven by one sector only.
• There are plenty of signals that we are in a bubble.
  • First, Valuation: Current valuations are not as bad now as they were in 1999 and 2000, but they are still far above what could be considered to be representative of fundamental value.
  • Instead, shares are being driven by narratives meaning that those that have a story regardless of its merits have a high valuation and those that don’t, do not.
  • Take for example the digital subscription narrative.
  • Here Netflix trades at 10.0x 2020 EV / Revenues, Apple is on 6.4x and Microsoft is on 9.9x all of whom have a great story to tell.
  • Meanwhile, AT&T which could end up as one of the biggest players in this space trades at 2.4x because it has made a complete hash of its narrative.
  • Elsewhere, pandemic darlings like Zoom, Peloton & DoorDash trade at 43.5x, 8.5x and 20.0x revenues, respectively.
  • Long gone are the good old days when one bought the technology sector at below 1.0x revenues and sold it above 2.0x revenues.
  • Second, Rights issues: Public companies tend to issue shares outside of M&A for two reasons.
  • Either they are in trouble and they badly need money or they think that their own valuation is too high meaning that selling equity makes financial sense.
  • Tesla (18.8x 2020 EV/Revenues) is clearly of this opinion as it is again issuing shares to raise another $5bn in cash to shore up its balance sheet.
  • The first it did this was in September when the shares were around $500 in a clear indication of what the company thinks of its own valuation.
  • The company has far more information than the market does meaning that this is a clear signal of what it thinks its long-term potential really is and how that matches the current share price.
  • Third, Market inefficiency: This could be the most telling signal of them all and relates to the notion that the level of sophistication in the market has fallen dramatically.
  • This is made very clear by the share price of Qualcomm which fell by 7.4% on the admission by Apple that it is working on its own modems.
  • Anyone who has done any research at all into Qualcomm for the purposes of investing will have found out that Apple purchased Intel’s cellular modem business some time ago.
  • Furthermore, Qualcomm’s current deal with Apple is only 6 years rather than the more normal 10 most likely because that’s how long Apple thinks it will take for it to produce a cellular modem as good as Qualcomm’s.
  • Consequently, the information that Apple is working on its own modems has been in the market for months, but it was only priced in when Apple admitted the fact which was rapidly spread by the financial media.
  • This strongly indicates that cash is flowing into tech stocks for no other reason than they are tech stocks which have weathered the pandemic better than the rest of the economy.
  • This is no basis upon which sound, reasonable and prudent investments can be made.
  • Fourth, FOMO: or fear of missing out. This is a well-known phenomenon where investments  are made purely on the basis of not wanting to miss out on the upside that is generally agreed to be in the near-term future.
  • These types of buyers pay no heed to fundamentals or valuation but simply purchase the asset because everyone else is.
  • This is typically retail investors who are the last buyers to come into the market and at some point, all of the buyers will have entered into the sector.
  • It is this that marks the top and as there will be no buyers left, the market will turn down and valuation and fundamentals will begin to matter once again.
• The net result is that I have no idea how long these valuations will persist, but I am certain that at some point there will be a big correction.
• This will also trigger to an overall correction in global benchmark indices as the sector now makes up a significant portion of the S&P500 and several others.
• It is this that has underpinned the overall recovery and when the tech sector reverses direction, the impact is likely to be felt right the way across the market as it was in 2001 and 2002.
• As a value oriented and contrarian investor, I am more than happy to sit this out and sift through the wreckage for the value once the dust has settled.