Long QQQ Short The VIX
There has been an ongoing debate in the investment industry when it comes to value and growth. Value had a fantastic run after the dotcom bubble burst in 2000. However, the last few years of the 2010s tipped the scales in favor of growth, with many high-flying tech stocks returning double digits in consecutive years.
Nevertheless, the fear of rising yields, inflation and unrealistic valuations has put a massive pressure on many of these tech names. A key question thus is: Are we about to witness another bursting bubble similar to what happened in 2000, or is this a great opportunity to buy many of our beloved tech stocks at a huge discount?
For the following reasons, we believe that tech stocks are heading for a strong rebound in upcoming quarters:
- Bull market is spreading, and that’s the sign of a strong market
- Inflation fears are over-exaggerated
- Interest rates remain low compared to historic levels
- America 2.0 is built upon technology
Bull market is spreading
The recent sell-off in tech was followed by money flowing to other sectors. This is a sign of what many call a “Healthy Bull Market”. Looking at the different sectors for the past 3 months, one trend is obvious: a major sector rotation is unfolding. There is a big move out of tech and into more cyclical stocks. The reason for this rotation is partially explained by a rebalancing at the larger funds as well as inflation fears. In the 6 months prior, tech had an amazing rally, and that caused many portfolios to become overexposed to technology. Therefore, many companies had to rebalance accordingly to limit their exposure to the technology sector.
As shown in the chart below, two of the best-performing sectors were energy and materials (when there is a fear of inflation, investors usually put their money in materials and energy, where the costs of inflation can be passed on to the consumer).
This trend cannot continue though because sector performance is quite often a byproduct of earnings expectations. For the first time in the past 3 years, the markets appear to be discounting higher earnings growth for companies like Home Depot, in comparison to tech darlings like Apple.
Our internal models show a higher earnings growth for Nasdaq and tech stocks despite the reopening of the economy and the progress being made on COVID-19 vaccinations.
Another hint as to why we are still in a bull market is based on taking a closer look at the share buybacks and dividend payouts of investment grade companies. As illustrated below, both buybacks and dividend payouts are increasing, thus signaling future earnings growth for the majority of U.S. companies.
Inflation fears are over-exaggerated
While the year-over-year inflation data is ticking higher, the following reasons explain why there is no major risk of inflation hitting above 3%:
1.There is a lot of slack in the economy
One of the reasons for inflation is when the economy is operating at full capacity and there is more demand than supply. Looking at the data, however, we can observe that there is still much slack in the economy. Unemployment remains high and labor participation has dropped significantly. These two variables alone are enough to offset any potential upward wage pressure.
While spending has picked up significantly, we are still far below pre-pandemic levels in many areas of spending. The chart below, from JPMorgan Chase, shows year-over-year consumer spending. Their data demonstrates how spending in many categories still has a long way to go before it reaches pre-pandemic levels.
2.Technology continues to act as a deflationary force
Many of the recent technological advances that we all benefit from, including AI and robotics, act as huge deflationary forces in today’s market. From social media to the goods being delivered by Amazon, consumers are consistently getting the lowest prices in the fastest time.
Interest rates remain low compared to historic levels
While 10-year yields have been ticking higher, we are still far below the historical average for yields and it does not seem that yields will return to their historical levels any time soon. Assuming a significant, but not record-breaking, uptick in yields, we have adjusted our models to factor into account 2.5% treasury yields (yields are currently at 1.742% and we expect they will continue to rise and then settle at around 2%). While this will compress valuation, there is still a 10-15% upside, especially in large-cap tech companies.
America 2.0 is built upon technology
While I am personally a big fan of index investing and believe that in the long run very few can beat the market, there has never been a better time to become a stock picker. The divergence caused by technological advancement is unprecedented and this time, in contrast to 2000, the adaptation of technology is going to be much, much faster. In addition, Biden is pushing for fiscal support to help with the electrification of America along with AI and many other areas that rely heavily on technology.
Of the $300 billion budget proposed by the administration for manufacturing, $50, $30, and $154 billion are proposed for the manufacturing of semiconductors, medical devices and facilities, and clean energy, respectively, and that will all at least indirectly affect the technology market. In addition, the $20 billion dedicated to creating innovation hubs and the $46 billion directed toward federal government purchases of electric cars, charging ports, and electric heat pumps for housing and commercial buildings will have a direct effect on the tech market.
In the proposal published by the White House on March 31st, $174 billion of the $621 billion proposed for transportation is planned for investment in the “American-made” electric vehicle market. These investments will cover the cost of tax incentives, consumer rebates, the building of a national network of charging stations, and the electrifying of transit vehicles, and all that again is reliant on technology.
The $100 billion budget dedicated to digital infrastructure and the $180 billion dedicated to research and development will further impact the tech market. Overall, Biden has dedicated over one-third (37.7%) of his proposed budget to tech and tech-related industries, and that is a very good indication of the importance of technology in the coming decade.
Conclusion
While it has been a very difficult past few months for tech investors, for the above reasons we remain strongly bullish on many of the tech names, especially the large-cap companies with reasonable valuations. The U.S. economy is set for a strong rebound and this will act as a tailwind. In our opinion, the evidence clearly demonstrates that tech is bound to take off again.
Keep checking the research tap as we will be breaking down the RBLX IPO and will break down Biden’s tax and infrastructure plan in details in the upcoming days.
As always, please email me if there are any questions or concerns.
Ardi