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Stocktake: Expect ‘big winners and big losers’ in tech land

The European stock market is much cheaper than the US and it’s likely to stay that way for some time

A monitor displays Apple Inc stock information at the Nasdaq MarketSite in New York on August 2nd. Apple Inc. became the first US-based company with a market value of $1 trillion, four decades after it was co-founded by Steve Jobs in a Silicon Valley garage and later revolutionized the worlds of computing, music and mobile communications. Photograph: Peter Foley/Bloomberg

Proinsias O'Mahony's face
Proinsias O'Mahony
Tue Aug 7 2018 - 05:00

Apple last week became the first US company to hit a $1 trillion market capitalisation, sparking the usual warnings about excessive sentiment and high valuations. Fact or fiction?

Actually, Apple remains inexpensive, says renowned finance professor Aswath Damodaran. Apple trades at a discount to the wider market; add in the fact it holds some $243 billion in cash, and it looks "reasonably" priced, said Mr Damodaran, Wall Street's so-called "dean of valuation".

As for the wider tech sector, today’s valuations are nothing like those seen during the 1990s dotcom bubble, but the largest companies are now so big that further growth will require them to take market share from each other, cautions Societe Generale’s Andrew Lapthorne. As a proportion of US GDP, the tech-heavy Nasdaq index is now larger than it was at the peak of the dotcom bubble in 2000, says Mr Lapthorne.

A similar point is made by AJ Bell's Russ Mould, who notes the five FAANG stocks – Facebook, Apple, Amazon, Netflix and Google – now account for 19 per cent of US GDP, more than the 15.5 per cent of US GDP reached by the five biggest companies in late 1999. The big guns can't all grow to the sky, says Mr Lapthorne. It's now "largely inevitable" there will be "big winners and big losers in the mega-cap technology space".

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European stocks dogged by profitability gap

The European stock market is much cheaper than the US and it's likely to stay that way for some time, according to Barclays.

In a detailed note, the bank last week said European valuation multiples have “moved sharply lower” this year. As a result, the MSCI Europe index is the cheapest it has been in two years. There are other positives. January’s “exuberant” sentiment is gone; a potentially weaker euro could be a tailwind in coming months; and earnings estimates have remained stable, despite trade tensions with the US.

Since 2011, Europe has underperformed the US “almost continuously”. This year, European indices are flat while the S&P 500 has gained 5 per cent. While the second half of 2018 might be better, Barclays sees a sustainable reversal as unlikely. Firstly, corporate buybacks have supported US stocks but buyback activity remains “subdued” in Europe.

Secondly, Europe is a value trade, an old economy market dominated by financials and industrials, unlike the tech-heavy US market. A sustainable rebound in bond yields is needed to trigger a style shift from growth to value stocks, but that remains unlikely, says Barclays.

Thirdly, Europe’s multi-year underperformance is mainly due to sluggish earnings. Profits should rise but at a softer pace than in the US, resulting in the US-Europe profitability gap remaining wide.

In short, Europe needs a “fundamental catalyst” to emerge. Until then, the wide US-Europe valuation gap should persist.

When August is bad, it’s really bad

The S&P 500 has enjoyed a decent few months, but history suggests the next couple of months might be trickier.

After rising for most of July, the index had “ticked into extreme overbought territory”, notes Bespoke Investment, so recent weakness likely reflected “re-positioning ahead of what is historically a weaker time of year for stocks (August and September)”. Seasonal weakness is also noted by LPL Research. Thre was the Iraqi invasion of Kuwait in 1990, the Asian contagion of August 1997 and 1998, worries over the global economy in August 2010, the US debt downgrade of August 2011, and panic over the Chinese economy in August 2015.

August has been “the one month where when it’s down, it’s really down”. Since 1980, there is no month with a worse average return when stocks are lower than August. A fluke, or a genuine seasonal anomaly? The former appears more likely. In any case, any dip may yet be a buying opportunity. Stocks gained in April, May, June and July, something that LPL notes has happened only 11 times. On each occasion, stocks rose over the final five months of the year.

Investors shrug off record earnings

It's been a bumper earnings season in the US thus far, but companies are not being rewarded with higher stock prices. Almost all companies – 83 per cent – are beating analyst estimates, notes Schwab. If that persists, it would a record. However, the average stock has actually lost ground in the day after reporting earnings, says Bespoke Investment.

This is especially true of the technology and telecom sectors; although three-quarters of tech companies have topped estimates, the average stock has fallen by more than 1 per cent on its earnings reaction day. The tech sector “could do no wrong” in the run-up to earnings season, notes Bespoke, and has easily outperformed all other sectors in 2018.

Little wonder, then, that traders have chosen to take profits in a typical case of ‘buy the rumour, sell the news’.

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