It’s déjà vu. From the renewal of the Cold War to a 1970s-style energy crisis, we’re running over familiar ground. Then along comes a re-run of the 2000-2003 technology sell-off to complete the set. History may not repeat itself, but it’s rhyming.
I remember the moment around the turn of the millennium when investors noticed that shares which they had been happy to ignore for the previous five years or so offered a port in the storm as the technology, media and telecom (TMT) sector bubble went pop. Lowly-rated, high-yielding businesses like Boots and Whitbread – boring old economy companies that had fallen off everyone’s radars – suddenly looked attractive amid the carnage of the tech wreck.
That market backdrop might sound eerily familiar as the performance of previously out of favour value shares continues to trump that of the market’s recent growth darlings. The MSCI World index may have fallen by 7pc so far in 2022 but that compares with a 25pc drop for the equivalent growth stock benchmark.
With a handful of these suddenly unfashionable shares representing a fifth of the value of the whole US stock market, this has unsurprisingly turned conventional investment wisdom on its head. The UK market, a pariah for years, has suddenly become viewed as a safe place to see out the storm. The US looks speculative by comparison.
Ever since the financial crisis, growth has been highly prized by investors. Companies that were able to deliver sustainably higher earnings became ever more highly valued. The consequence has been one of the worst periods ever for lower growth but cheap value shares. Between 2015 and 2022 growth stocks went from being cheaper than value shares to twice as expensive. Much of the same thing happened between the mid-1990s and 2000.
And the longer this upward re-rating of growth stocks went on, the more ingenious investors became in their justifications for the higher prices they were prepared to pay to stay on the bandwagon. Just as they had done 20 years earlier, investors chose to ignore inconvenient truths. If anything contradicted the favoured growth story, it was simple enough to just disregard it.
Back in the dot.com period, people talked blithely about eyeballs, as if the fact of someone looking at a website would pay the bills. More recently we have become comfortable talking about ‘addressable markets’, as if someone’s simple existence made them a consumer of our goods or services.
I knew that we were approaching the end of the line during the dot.com madness when cash raised to invest in unspecified internet stocks traded at a multiple of its actual value. A shell company holding, say, AUD$50m of cash and nothing else might be valued in the stock market at AUD$250m. When you are asked to pay AUD$5 for a AUD$1 coin, you know something is wrong. But that is what early investors in internet incubator stocks were doing and soon enough they realised it made no sense.
Since the start of the year, technology shares have sold off significantly. The price declines from their recent highs of shares such as Apple, Amazon, Google-owner Alphabet, Facebook-owner Meta and Microsoft range from 20pc to nearly 50pc. So, it is clear that this may be more than just a rotation from growth to value.
There have been some plausible explanations for the sell-off. One is the idea that companies with much of their growth still in the future are worth less in today’s money when their present value is calculated using higher interest rates. The flaw in this argument is that many of the fallers are highly profitable and cash-generative today. They are not the blue-sky dream stocks that captured investors’ hopes in 2000. So it is likely there’s more to this than rising interest rates.
I think the drop in technology shares is more a reflection of greater risk aversion in an uncertain economic and political environment. War, inflation and the threat of recession make investors nervous. And, in those circumstances, it is only natural to sell what has gone up the most, is most highly valued and has already delivered a decent profit.
Investment returns are inversely correlated to the price you pay at the outset. The higher the price relative to earnings or assets or the dividends that a company pays, the lower the likely returns over time. There can be periods of time when this truth can be ignored. This can go on for many years. But in due course the fundamentals will re-assert themselves.
So, what are those fundamentals telling us today? Actually, a more positive message than a repeat, or even a rhyme, of 20 years ago might suggest. With some notable exceptions (Amazon still looks pricy), the tech stocks that have fallen so far this year have dropped to a level at which they are valued at little more than the traditional defensive stocks that investors turn to in a downturn – consumer staples, pharmaceuticals and the like. And they are delivering higher and more sustainable profits growth. In some ways they can be considered the new defensives.
I’m not calling the bottom of the tech sell-off. The rotation from growth to value may have a way to go yet. Markets tend to overshoot. But, unlike 20 years ago, the remarkable performance of growth shares was largely justified by their superior earnings performance. And that means that the rebalancing of valuations that took three years two decades ago may well have run its course in six months.
Tom Stevenson is an investment director at Fidelity International. The views are his own.
