Bursting the technology bubble

Mawhinney, a veteran investor, protested Afterpay’s stock price when it crossed $100 in 2020, months before it peaked, questioning the market’s sanity to drive the price upward.

Anton Tagliaferro, founder and investment director of Investors Mutual, one of Australia’s best-known value investors, echoed the sentiment. He marked the moment when the buy now, pay later price hit the triple digits by questioning whether the market “priced the fundamentals in correctly.”

People like Mawhinney and Tagliaferro were dismissed for out of touch with technical triumphalism. Their performance suffered from their reliance on old-fashioned industrial stocks like Brambles, Amcor and Orica and out-of-favor oil companies like Woodside.

Now, the dramatic shift in technology stocks has confirmed their skepticism, while the growth funds that previously outranked them are struggling.

Many investors mistakenly view tech stocks as “some sort of holy grail,” Tagliaferro says, rather than seeing them as “just another sector of the market.”

“Yes, there have been some spectacular winners, like in mining stocks, but for every success, for every Facebook, there will be many that don’t make it.”

Simon Mawhinney, chief investment officer of Allan Gray, remains skeptical of technology stocks despite the fall. Renee Nowytarger

So, how did stocks in the tech companies that represented a wave of disruption and innovation break apart so quickly and what happens from here?

If there can be one factor that can claim responsibility, it must be the moment when the illusion of endless free money ended.

“As you approach the speed of light, the laws of Newtonian physics fall apart,” said Chris Tynan, an investment analyst for DNR Capital, a Brisbane-based fund manager.

“As you approach zero nominal interest rates, the laws of valuation fall apart. That’s why you saw companies trading at 50 times the revenue and these cryptocurrencies appear and disappear. It just didn’t make sense.”

Now inflation has changed the game. Central banks are reacting aggressively to rapidly rising consumer prices with higher interest rates, forcing investors to rethink the value of future gains in the technology complex.

“When the Fed said they would do everything they could to get inflation under control, it really started happening,” Younes said.

Rising prices devastate technology stocks as investors lower the current value of future earnings, hitting the market value of profitable companies or so-called concept stocks hard.

Higher interest rates also increase the cost of capital, putting an additional burden on businesses that rely on borrowed money to keep afloat.

“If you burn cash and the profits you have run out for more than five years, you’ve been hit hard,” explains Tynan.

“What’s much more valuable is that companies are generating money now, in the form of energy and raw material stocks.”

Anton Tagliaferro, founder and investment director of Investors Mutual, said tech company valuations were drifting off the fundamentals. Dominic Lorrimer

Still, there’s more to the tech wreck than higher interest rates. US mega-cap stocks such as Amazon, Netflix and Meta are highly profitable and therefore less sensitive to interest rate movements. But they too have been given a seat belt.

“Most of the growth in their valuations [during 2020 and 2021] was actually earnings growth,” says Tynan, who he attributes to a “progress in digitization” in the early stages of the pandemic.

“What’s happening for them now is there’s a slowdown in revenue. They are less exposed to interest rates, but there is a significant slowdown in earnings.”

In March, portfolio managers at T. Rowe Price, one of the world’s largest fund managers and one with a long history of investing in growth companies, spoke with Amazon executives.

“They were pretty confident about the recovery in volumes and trading,” said Sam Ruiz, a Sydney-based investment specialist for fund giants, before abruptly changing the tone two months later at a follow-up meeting.

“In six or seven weeks they told us that everything had changed. Now they have suddenly made their logistics and storage capacity too large and they have too many staff.”

A similar dynamic has changed the growth ambitions of tech companies, leading to a wave of layoffs and employee freezes at Netflix, Meta, Twitter and Amazon.

“It’s amazing how a 50-75 basis point hike by the Fed is already causing a demand sell-off that’s already impacting margins,” said Ruiz.

The combination of the soured environment and falling valuations means these once high-flying technology stocks are tumbling and weighing on the broader market. But not everyone believes it’s time to abandon technology.

“If you’re a long-term investor and willing to bear the short-term volatility, then I think it’s a good time to invest,” said Thomas Rice, portfolio manager for the Perpetual Global Innovation Share Fund.

Rice’s largest holding is in US online residential real estate company Opendoor Technologies, which has halved in value this year. He says the company was wrongly overtaken by the sale.

He also has an eye for enterprise software companies such as Microsoft, ServiceNow, Salesforce and MongoDB, which have become more attractive after this year’s declines.

Managers of global innovation and disruption fund Holon Photon, which owns names like Coinbase and Tesla, are just as optimistic about large-cap technology stocks as they were two years ago.

“The opportunity now lies in a myriad of great technology stocks,” said Holon research director Tim Davies. “This is the chance to do the work to go ‘I want to buy’.”

The fund added a position in Meta and bought Netflix after shares fell sharply in April, in addition to charging Alibaba and Tencent, two Chinese tech giants that went under last year.

Cathie Wood, the queen of tech bulls who runs the ARK Innovation Fund, has also doubled her bet on technology, despite a collapse in the value of her portfolio holdings this year.

Cathie Wood, founder of Ark Invest, remains optimistic about technology stocks. Sam Mooy

On Thursday, Wood told attendees at the Morgan Stanley conference in Sydney that “we are on the brink of the most explosive era of innovation in the history of the world”, and that the mojo would eventually return to tech stocks like Zoom, Tesla and Roku, which are among its fund’s largest holdings.

For others, however, the skepticism that is weighing on technology stocks will persist against the backdrop of tightening financial conditions and the looming recession in the global economy.

“There’s some compelling value, but I don’t think it’s one of those companies that captures the hearts and minds of ordinary people,” said Allan Gray’s Simon Mawhinney.

“Take BNPL, they haven’t made any money at the best of times. How on earth are they going to make money in the worst of times?”

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