Market Bulletin (26/11/2018)

Technology revolutions

Steamships and railroads opened up the nineteenth century world; electricity, gas and oil powered the new industrial processes of the twentieth. Such shifts were mirrored on stock markets.

In 1917, the largest stock on US markets was US Steel, followed by American Telephone & Telegraph, Standard Oil of New Jersey and Bethlehem Steel. Fifty years later, the top ten stocks still included three oil companies, General Electric and General Motors.

But the largest was a computer company, IBM. And today – half a century later – it is information technology stocks that dominate the view on the S&P 500, accounting for the five largest stocks and driving most of the market activity. Some have called this digital electronics takeover the ‘Third Industrial Revolution’.

Last week, after a phenomenal couple of years on markets, the revolution lost a few converts. On Monday and Tuesday, the FAANG stocks took a hit – at one point, they were 20% down from their 2018 highs. Watching paper losses of billions of dollars can be unnerving, and there are undoubtedly concerns about the pressures faced by the industry, such as the apparent expiration of Moore’s Law (whereby computer chip capacity has been doubling every two years since the ‘70s); increasing regulation (and, potentially, tighter antitrust rules); trade tariffs; and new taxes. A slew of negative news stories hasn’t helped either, stoking public anger and sparking employee walkouts.

In this light, it is worth remembering a few fundamentals. According to Statista estimates, 46.8% of the world’s population used the internet last year; and 50.8% will do so next year. Moreover, online accounted for 10.2% of global retail sales last year, and should account for 13.7% next year. Advertising, of course, is following the money, and all this is taking place while the global population continues to rise; within that population, 46.6% of households had a home computer last year, forecast to rise to 47.6% this year. In short, this revolution is not for turning.

But even the best trades can get overcrowded. So, did last week’s fall represent the triumph of fear, or of reality? The answer may depend – whenever does it not? – on which individual stocks you hold. All the same, there may be signs of short-termism in the recent investor turn.

“The majority of our large technology related holdings, including Alphabet, Visa, Microsoft and Oracle, have not been impacted materially by the share market correction over the past few months, but a few have seen material recent price corrections, most notably Apple and Facebook,” said Hamish Douglass of Magellan Asset Management, manager of the St. James’s Place International Equity fund and co-manager of the Global Growth fund. “Much of the share price reaction relates to short-term market sentiment rather than any change to the underlying economics or business outlook. We continue to have a high degree of conviction in the investment cases for each of these companies and believe each will deliver attractive returns over our investment horizon.”

One concern is White House policy. Last week, the Commerce Department launched a public consultation on “whether … certain emerging technologies are essential to the US” – and therefore need new export controls. For decades, these technologies originated from the public sector; even the iPhone’s most life-changing functions – GPS, touchscreens, voice recognition – ultimately derive not from Silicon Valley innovation but state-funded research. For today’s emerging technologies, that is no longer the case – and new export controls for technology companies may yet be the result.

What the technology giants have proved themselves masters of is commercial application, and they are already currying official favour to protect their market hold. Google is set to increase its vetting of adverts before the EU elections in May 2019, while Facebook has pledged tougher security and even funded journalism training. (It uses less self-denying methods too; last week, it hired a senior Department of Justice official as an associate general counsel.) But opportunities in the sector are not limited to the biggest names.

“In the software space, we hold Workday and Atlassian, which are category leaders in their respective markets,” said David Levanson of Sands Capital, co-manager of the St. James’s Place Global Equity and Global Growth funds. “They have very attractive, defensible and visible business models. Their subscription models feature high percentages of recurring revenue, typically under multi-year contracts, and very high retention rates, which helps in the event of a downturn. We also believe many of the secular trends that should benefit our businesses remain intact.”

Summit discord

Technology is not the only headwind on markets. Last week’s Asia Pacific Economic Cooperation summit failed to publish a communiqué for the first time since APEC’s founding 30 years ago. Behind that failure lay US-China tensions and a US decision to help Australia build a naval base in Papua. (Expectations are low for this week’s G20 in Argentina.) Moreover, the price of a barrel of Brent crude oil slipped still further last week, falling below $60 and pushing down energy stocks.

Meanwhile, the OECD warned that global growth is already slowing: global export orders, industrial production, retail sales and container port traffic have all exhibited the same rapid deceleration in recent quarters. Like US debt and Fed rate rises, such trends unnerve investors. The S&P 500 finished down for the week. Even last Friday’s Thanksgiving boost on markets was short-lived; Best Buy, Target, Macy’s and other leading US retailers had reported enjoying a retail boost in the wake of store closures or bankruptcies of their longer-standing competitors, such as Toys ‘R’ Us and Sears.

If trade tensions hurt the US, they may hurt China more. The Shanghai Composite index is now down more than 20% for the year – the S&P 500, on the other hand, is close to where it began. Indeed, the recent slide in US tech stocks looks less frightening when set against the past couple of years. The S&P Information Technology index opened 2016 at 721 points; even after this year’s precipitate fall, it still sits above 1,100, a rise of well over 50% in less than three years – and that’s before dividends.

The B-word

Stocks in the UK, of course, have had a much tougher year than the S&P 500, making last week’s dividends news all the more gratifying. Payouts reached a third quarter record of £32.3 billion, with year-on-year growth of 6.9% comfortably outpacing inflation. The smoother path of dividends provides a valuable counter to the recent spike in market volatility.

The FTSE 100 struggled through the week but ended only marginally down. Theresa May’s success in agreeing a Brexit deal with the EU delivered sterling a boost midweek, and the EU formally signed up to the deal at the weekend – but Westminster will be a harder sell than Brussels.

Investors have also been concerned about Italy’s budgetary plans, although the worries may now be priced in – and the yield on Italian 10-year debt actually fell last week. While Italy’s population may be supportive of the expansionist budget, they are apparently more reluctant to risk buying up the debt, as a disappointing issue last week went to show. Nevertheless, some recent analysis suggests that Italy enjoys a “high fiscal multiplier”, meaning that even a modest increase in spending should have an accelerated effect on growth. That may yet mollify an anxious EU.

Beyond Brussels

As in Italy, so in the UK – political wrangling in Brussels can all too easily distract from ongoing challenges at home. Figures released last week show that the number of adults aged 85 or more who will need constant care is set to double to almost 446,000 in England over the next 20 years. The over-65s requiring constant care, meanwhile, will increase by more than a third, reaching a million in 2035. This places a major burden on state and family alike, underlining the imperative for early and comprehensive financial planning to cover potential costs.

Magellan and Sands Capital are fund managers for St. James’s Place.

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