2023/24 Theme: Big Tech Stocks - An Update On Where To Go From Here?
Two weeks ago we provided a brief update on small caps.
The takeaway was essentially to hold serve:
Keep watching these stocks closely / expect them to do well as long as economic growth holds steady.
But that analysis on smaller US companies was really only half of a two part argument at the end of last year.
The other half, which we have also mentioned in multiple edition, is be very cautious of piling into the Big Tech companies going forward.
This seems pretty churlish in a way. Tech of course, had a fabulous 2023. The NASDAQ was up 43% for the year, nearly double the S&P 500's 23% gain. And in that wider index of large US companies, the technology and e-commerce companies averaged a gain of 57%.
And the biggest tech companies did even better still. The Super 7 companies - in no order, Microsoft, Tesla, Nvidia, Apple, Amazon, Meta and Alphabet - we have written about so often were up 75%. They constituted over 30% of the S&P 500 by the end of the year.
Maybe the most mind blowing stat of all:
Those seven companies were responsible for nearly half the S&P 500's gain in 2023. The other 493 companies combined were up a collective 12%.
Just hard to truly believe.
So, this was a point we made frequently throughout 2023:
If you are wondering why the market is going up, "big tech stocks" would be the easiest possible short answer.
This continued for nearly the first 10 full months of 2023 until, finally, the index broadened a little bit over the last two, far more euphoric months of the year. The days may have been getting shorter but investors became even more optimistic in the 4th quarter as the darkness closed in last December.
So, what now? If 2024 could be a good environment for small caps (we hope), what does that mean for other types of companies?
We remain cautious but there is no denying that Big Tech has started the year incredibly strongly. The S&P 500 is up 2.5% so far in 2024 but the Tech sector is already up over 5.9%. Many of the biggest names are leading the way....
So, why are we cautious?
In one sentence:
Because over valued assets can always go higher but the problems are piling up.
The sweet spot for small caps is resilient economic growth and lower interest rates. This is obviously very narrow. As we have mentioned multiple times, you have to be very careful for this very reason. The optimal conditions for small US companies in relative terms are very tough to find. They are the light breeze/sunny weather of a perfect spring day compared to the far more rugged large enterprises in the S&P 500.
The sweet spot for large tech caps is very different. One of the many positives of the largest technology behemoths is that they do well in many scenarios.
This makes them very flexible companies to own which has reinforced the groupthink behind so much of their rise. If something does well under most conditions then why not just own it and forget everything!
When investors are uncertain they become very attracted to Big Tech's ability to safely make lots of money in all types of economic conditions. These same companies are also considered very safe investments due to their lack of volatility.
One of the times that the largest tech companies do very well is periods of uncertainty. This occurs when, like now, suddenly it becomes a little unclear precisely what will unfold.
The big uncertainty at present is around two questions:
Will the Fed start cutting interest rates?
And when will they do so?
These questions have risen in prominence as the euphoria of the end of the year has gradually died down and many investors have, newly sobered by the New Year, taken stock of the ever resilient US economy and the fact that the US central bank may not cut rates in March after all.
We get all of this. Truly.
But there are still three reasons to be very skeptical of Big Tech here. The reasons are as follows:
Profits.
Policy.
Popularity.
These three Ps are pretty important!
First off, the tech companies are at a valuation where even breakout earnings make very hard to sustain. In other words, the stock price is already at a level that expects huge profits. This will be very challenging to do.
Second, is the fact that policy - here in the US and abroad - are both strongly set against many of these profits. From anti-trust efforts in the US to the very real sanctions and regulations forbidding them from selling to China or otherwise, policy is hurting, not helping. The drift towards further decoupling is ever present.
Lastly, the popularity of these companies is a trap. Yes, over the short term they seem like a no brainer trade and that will send their shares higher. But their shares are already over valued and only becoming more so. We know how this ends.
Last year Big Tech was expensive but relatively cheap compared to their sky high profits, especially if there was no recession. This year that gap has been closed and instead there is a higher and higher expectation around profits related to AI.
The belief in the markets has started to bleed from "Big Tech rarely go down" to "Big Tech companies never go down" and that is a very dangerous place to be.
Our big message would be not to chase the hype. There are real risks in owning these companies, they just aren't discussed or understood.
The real question is perhaps: "will tech stocks keep going up" but rather "can the market go up if tech stocks do not?"
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