Technology stocks are most vulnerable to central bank error, and disruption from competition and regulation, according to Denny Fish, manager of the Janus Henderson Global Technology and Innovation fund.
The technology-focused fund manager anticipates that there will be a “normalisation” of the technology sector in 2022.
“In the past 20 months, tech has experienced an acceleration of the digitisation of the global economy, historic supply chain disruptions and a backdrop of highly accommodative monetary policy,” he said. “These developments have the potential to shift over the next few quarters.”
Technology stocks have soared since the onset of the global pandemic 20 months ago, with the MSCI World/Information Technology index outpacing the gains of the wider MSCI World index by 25% over the period.
Performance of MSCI World index v MSCI World/IT index over 20 months
Source: FE Analytics
Fish said the near-term risks to tech stocks fall into two categories: macro and sector specific. When it comes macro risks, he said the likelihood of rising interest rates introduces the risk of policy error from central banks.
“Should central banks move too quickly, they could squelch economic expansion,” he said. “This would be most harmful to ‘cyclical growth’ stocks, namely semiconductors.
“Secular growers would also be at risk as the value of their distant-future revenue streams would be diminished by higher discount rates,” he added.
He said underappreciated risks unique to these secular growers was that these disruptors get disrupted themselves – something that the market has failed to consider.
“The past few years have seen an unprecedented number of businesses and industries upended by innovative companies,” he explained. “Given the rapid pace of change, there is no rule that yesterday’s disruptors won’t fall victim to the next wave of technological advancement and scrappy upstarts.”
He also warned of the regulatory risk that “continues to lurk”. Many of the big technology giants such as Amazon and Google continue to face multi-million-dollar fines for alleged anti-competitive behaviour from governments around the world.
Fish said: “While China clamped down on the tech sector in one fell swoop, Western governments may ultimately achieve the same ends, but in a more incremental manner.”
Not all is lost for technology investors however. Fish said that the semiconductor industry could be one area of interest given the impact of the semiconductor shortage.
He argued that it might take until the end of 2022 before chip makers can fulfil their outstanding orders, which bodes well for the bottom-line of chip manufacturers.
“Equilibrium, however, is a moving target given strong secular and cyclical demand for semis,” he added.
“We see sustained tailwinds for the advanced chips powering novel technologies like artificial intelligence and for the memory chips and microcontrollers that have become ubiquitous across industries.”
Although it may seem that technology companies share a disproportionate share of corporate headlines, Fish said it is “no accident”.
“Given the potential for delivering increased efficiencies across the economy, it’s our view that tech companies will command an ever-greater share of aggregate corporate earnings and, thus, equity returns as the digitisation of the global economy continues,” he said.
The biggest takeaway for investors considering tech stocks going forward, according to Fish, is to maximise exposure to the technologies and businesses that will drive earnings and underweight the legacy names facing disruption and diminishing market share.
“Right now, tech stands to benefit from both cyclical- and secular-growth tailwinds,” he said. “That is not always the case and investors should be mindful of the forces set to redefine the sector over the longer term and the current environment, which may either be favourable for tech companies or present temporary headwinds.”
He said investors needed to recognise the distinct characteristics of companies that exhibit resilience, and those that exhibit optionality.
Resilient companies tend to be those that are more mature with consistent earning streams that allow them to weather hard times, he explained.
Whereas optional companies are those that can potentially deliver above-average earnings growth as they establish new markets and capture more share of existing markets.