There’s no bigger investment question right now than “what’s the right weighting for Big Tech in a US equity portfolio?” As a reminder, “Tech” is a very large part of the S&P 500:
- Apple, Microsoft, Google, Tesla, Amazon and Facebook are 24 percent of the S&P. If they were their own sector they would be almost 2x the next largest group (Health Care, 13 pct).
- Apple and Microsoft are 43 percent of the Technology sector
- Amazon and Tesla are 40 percent of Consumer Discretionary
- Google and Facebook are 45 percent of Communication Services
The question of “what to do with Tech?” is therefore second only to “how much of an allocation to US stocks do I want?” in importance. To our thinking, the answer lies in considering the merits of even-weight, overweight and underweight arguments.
Here’s our take on each:
Good reasons to underweight Big Tech:
Regulatory risk. While less relevant for Tesla, every other large US tech company will see incremental scrutiny in the coming 24 months from both Federal and state regulators. While markets have entirely discounted these developments as of today’s news flow, it’s hard to know where things will end up.
Better places to put capital. In order to overweight cyclicals, you have to own less of other groups. While our preference is to stay away from Consumer Staples and Utilities, underweighting Tech or Communication Services is another way to do it.
Good reasons to equal weight Big Tech:
Solid business models and great managements. As we outlined last week, Big Tech had big earnings leverage in Q4: 40 percent net contribution margins on average. That’s why we don’t worry too much about standard price/earnings multiples with these names. Managements here know exactly how to make profits grow faster than revenues. Moreover, unlike China’s version of Big Tech (BABA, Tencent, etc.), they don’t really compete with each other.
They are the backbone of global disruptive innovation. Big Tech is the “hub” of every disruptive “spoke” on venture capitalists’ drawing boards around the world. In essence, owning Big Tech is leverage to whatever comes next out of Sand Hill Road.
Good reasons to overweight Big Tech:
Hedge against the uncertainties of post-pandemic economic recovery. If you’re less sanguine than we are about the pace of global economic recovery, Big Tech is a crisis-tested place to park capital. This is actually playing out a bit year-to-date, with the average return of the 6 names we’re calling Big Tech at +8.6 percent. That’s more than double the S&P’s 4.1 percent return. (MSFT, GOOG and TSLA the winners, AAPL, FB and AMZN losers). The large cash balances at most of these companies are, of course, also a plus.
Long run trends. A look at the last 10 years of US societal capital allocation shows that Tech relentlessly hoovers up market capitalization from other sectors. Can we really expect the next 12 months to really be that different?
One last point before we conclude: no, we don’t think the rise of indexing has artificially skewed Tech valuations. As a wise friend with +30 years of Wall Street experience pointed out to us recently, IBM, Intel and Cisco have been in the S&P 500 since 1957, 1976 and 1993 respectively. Their forward 12-month multiples at present are 14x, 13x and 15x. If indexing really drove marginal valuations the way some market commentators say, those valuations wouldn’t be literally half of Tech’s 27x forward multiple.
Summing up: we believe the best choice at present is to be even weight Big Tech. That may sound a bit milquetoast but 2021 is not 2020, when we often defended a positive view on Tech in these notes. There’s better places to make money (cyclicals), but taking a portfolio too far out of its lane this year will be the easiest way to lose performance. Technology writ large is the market’s anchor. Cutting the rode and floating free has little upside in our view.