Markets & Economy

The pandemic has caused pain for many businesses, but the tech industry seems to be one area that has come out on top. Not even an economic shut down, a global pandemic, nor geopolitical turmoil can put a damper on the run in tech stocks.

While there are dozens if not hundreds of tech companies profiting off this boom, a few ‘mega-cap’ tech stocks have captured an overwhelming amount of market power and attention. Just five stocks make up more than 18% of the Russell 3000 and 24% of the S&P 500.

These companies are driving the market for several different reasons. Most importantly, they have dizzying growth rates for their size and are substantially benefiting from the COVID-induced increase in at-home spend. Today, we’re taking a closer look at forces impacting the major tech stocks, as well as trade issues, anti-trust, and more.

Prices on the Rise

The dominance of technology is giving some investors déjà vu from the late 90’s and early 00’s. This is especially true when you consider the enormous surge in certain groups of tech stocks, where prices have risen far faster than business fundamentals (i.e., rising valuations). In general, valuations are becoming stretched, and especially in trendier areas.

Of the big five mega-cap stocks in particular (Apple, Amazon, Microsoft, Facebook, and Google), we do not think they are in a bubble. While they each have high and increasing weightings in the major stock indices, we don’t consider their impact to be outsized. These companies have very strong business fundamentals and have all been beneficiaries of the changes wrought by the pandemic. They are growing quickly and at extremely high profit margins as compared to other companies, and these strong underlying fundamentals are the case for select other areas of tech as well.

The real concern lies with companies whose cash flow and other fundamentals are mismatched with their high prices. These are the companies that have the potential to enter bubble-like conditions. Many high growth Software-as-a-Service (SaaS), eCommerce, and FinTech stocks are showing these conditions currently, and we remain wary of them for the time being.

An Eye on Trade Relations

Beyond business fundamentals and valuations, there are a few key risks facing tech. First is US-China relations, which are deteriorating as 2020 starts to come to a close. This is exemplified by recent events with semiconductor production and Huawei.

US action is putting significant pressure on China’s ability to become self-sufficient in producing semiconductors. Semiconductors are a critical area of strategic concern, and ample access is vital and necessary for every modern nation. As the US puts further pressure on China’s ability to access semiconductors, we don’t know how China may respond or where the lines in the sand will be drawn.

Increasing Regulatory Attention

A second key area of risk is regulatory and anti-trust. We always maintain a close eye on ongoing key risks facing our investments, and regulatory attention has only increased in recent years.

We've looked closely at the anti-trust issue before, and our perspective is a bit different than most. What we’ve found when looking at history is that increasing regulatory oversight is not necessarily an automatic reason to sell a stock. In dozens and dozens of forgotten cases throughout history, regulatory reviews led to little or no change to the core of the business, and if anything, we found that anti-trust scrutiny is often a signifier of the strength of the business model.

While there have been regulatory actions that have led to material business changes, these are far and away an exception to the rule. We believe that fundamentals and valuation win out against regulatory scrutiny.

Keeping Perspective

The tech space is growing rapidly, and the virus has only exacerbated existing trends at play in the technology sector. Those companies who were on the decline have continued to do so, and vice versa.

At Manning & Napier, our stock selection strategies focus not only on finding companies with decent valuations, but also on finding companies with strong underlying fundamentals. Even if a company’s valuation multiples appear expensive at first glance, we are willing to buy if we determine that the valuation is attractive, and fundamentals will remain strong into the future.

This material contains the opinions of Manning & Napier Advisors, LLC, which are subject to change based on evolving market and economic conditions. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.