US large cap Technology is up 40.9% year to date, but that headline number is misleading; not all Tech is having a great year and that robust return is actually very concentrated. Consider:
- Microsoft and Apple are half that return. MSFT is up 49.0% YTD, and with its average 18% weight in 2019 that performance is worth 9 of the 41 points. Apple is +69.0% YTD, and with an average 18% weight that’s worth 12 points.
- Several top-weighted names are underperforming the S&P 500’s 25% YTD return: Intel (+20.5%), Cisco (+1.3%), and Salesforce (+15.0), for example.
- While many other leading Tech names are doing better – Visa (+38.4%), MasterCard (+52.2%), NVIDIA (+58.9), and Accenture (+43.0%) – since their weightings are much lower than MSFT or AAPL their contributions to that 41% Tech return are just 1-2 points each.
That Q4 2018 was so rough is also confusing matters when it comes to assessing Tech’s real contribution to longer-run US equity returns. To adjust for that let’s consider the following YTD and 2-year return data for a variety of Tech stock measures:
- For comparison, the S&P 500 is up 25.1% YTD but just 17.2% over the last 2 years on a price basis.
- The S&P Tech sector is 40.9% higher in 2019 but only +35.2% over the last 2 years.
- The PHLX Semiconductor Index is up 48.7% this year, lower than its 2-year return of 37.4%. The largest weightings here are NVIDIA (8.9%), Intel (8.4%), and Broadcom (8.3%).
- The S&P NA Expanded Technology Software Index is up 30.7% YTD but unlike our other examples is actually higher by 44.0% over the last 2 years. The largest weightings here are Microsoft (8.9%), Adobe (8.8%) and Salesforce (8.3%).
- The Dow Jones Internet Index is only up 15.6% YTD but 21.8% higher over the last 2 years. The largest weightings here are Google (10.0%), Amazon (8.9%), and Facebook (8.1%).
The upshot here is that while several Tech subsectors are underperforming in 2019 (Software and Internet), all are still winners versus the S&P over the last 2 years. Considering that timeframe includes the entire US-China trade war, a slowing global economy, and incremental regulatory concerns, that strikes us as remarkable.
As for what will happen in 2020, the most important issue is just how much good news is baked into Tech stocks after their 2-year runs:
- FactSet reports that the S&P 500 Tech sector currently trades for 20.7x forward year earnings, the second most expensive group in the S&P. It also has the largest exposure to non-US end markets, at 56% versus an S&P mean of 38%. That means global economic growth is key for the group.
- Analysts expect the sector to go from 2.3% revenue growth/0.0% earnings growth in 2019 to 6.3% revenue growth/9.5% earnings growth in 2020.
- The same high expectations apply to Tech names not actually in the Tech sector. Analysts have 31% earnings growth in their Amazon models, 17% for Google, and 41% for Facebook.
The bottom line: while we live on a corner lot in the perma-bull neighborhood for Tech, we absolutely understand that valuations here look steep. The last 2 years of structural outperformance have made them so. In our defense (and the group’s as well), Tech remains the one group with a powerful long-term growth story. High valuations may limit 2020 returns, but Tech remains a must-own group regardless.