Thursday, July 9, 2020

Are technology stocks the big winners of the COVID-19 pandemic?

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The coronavirus pandemic has brought our dependence on technology into focus, as businesses and consumers move online to work, shop and socialise. Tech stocks are leading the charge as global equity markets bounce back, and appear to be emerging as the big winners of the crisis. What does this mean for investors?   

 

Tech driving the rally

The recent global stock market rebound has been nothing short of spectacular. On June 3, LPL Financial noted that the S&P 500 had returned 37.7 percent over the previous 50 trading days, the largest 50-day rally in history. A closer look reveals which sector was behind this stellar performance: technology.

The index’s five highest market caps are all tech companies, with Microsoft followed by Apple, Amazon, Alphabet and Facebook. These stocks have topped U.S. indices since the 2008 credit crunch. When the pandemic derailed this rebound at the start of 2020, the S&P 500 index had gone up by nearly 400 percent from its 2009 low and the tech-rich Nasdaq 100 index more than 700 percent.

S_P500_Chart

Far from affecting tech giants, COVID-19 has made our reliance on them even more acute. With millions of people under lockdown at home, digital commerce and services have flourished, boosting software giant Microsoft, online retailing giant Amazon and internet streaming service Netflix.

Another seemingly big winner to emerge is Zoom, the video-conferencing company that almost every office worker has used at least once during lockdown. From U.S.$20 per share at the start of the year, the stock was trading close to U.S.$250 on June 29.

Microsoft has also seen demand for its video-calling services, Teams, rocket. Its shares rose to nearly U.S.$200 at the end of June, from U.S.$160 on January 2. Its Cloud offerings – including Azure and Office 365 – have also been crucial in maintaining business continuity and facilitating remote working during the health crisis.

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Overall, stocks exposed to digital transformation, where technology is used to modernise operations, enhance customer interactions and improve worker productivity, have had a good ride recently.

“As Covid-19 impacts every aspect of our work and life, we have seen two years’ worth of digital transformation in two months,” Microsoft CEO Satya Nadella recently remarked. “There is both immediate surge demand and systemic structural changes across all of our solution areas that will define the way we live and work going forward,” he added.

In MENA, technology stocks are worth keeping an eye on since the region produced its first unicorns, Souq.com - subsequently acquired by Amazon in 2017 and Careem, snatched by Uber in 2019 for a whopping US$ 3.1 billion. The technological revolution in the Middle East “both relevant and urgent” and the region could prove a fertile soil for generating start-ups argues the World Economic Forum. “Relevant because we have a young, digitally-savvy population with some of the world’s highest levels of smartphone penetration - in Bahrain and the UAE, there are up to twice as many phone subscriptions as people. Urgent because the region suffers from high youth unemployment rates - nearly 30% in many of our countries,” the WEF explains.

 

Bleak economic outlook

However, the disconnect between financial markets and economic prospects is becoming increasingly obvious. Central banks are introducing unprecedented stimulus packages to stave off what could be the most severe recession in advanced economies since the Second World War, according to the World Bank.

“The current episode has already seen by far the fastest and steepest downgrades in global growth forecasts on record. If the past is any guide, there may be further growth downgrades in store, implying that policymakers may need to be ready to employ additional measures to support activity,” World Bank Prospects Group Director Ayhan Kose stated.

In its June 2020 World Economic Outlook Update, the International Monetary Fund (IMF) predicted that global growth would contract by nearly 4.9 percent in 2020. Next year, global GDP will be about 6.5 percentage points lower than in the pre-COVID-19 projections of January 2020, says the IMF.

 

The bigger picture

Pre-COVID, many analysts argued that tech stocks were expensive with overinflated valuations, prompting fears of another tech bubble.

To determine whether a stock’s valuation is fair, it is important to look at growth prospects: not just company forecasts but the way in which our world is changing. In today’s era of disruption, we must recognise that although the dominance of tech giants seems unchallengeable, nothing is set in stone. Once-powerful brands like Nokia and Blackberry are cases in point.

In a 2018 report about “superstar firms,” McKinsey Global Institute remarked that in each of the past two decades, nearly 50 percent of all market leading firms have fallen out of the top 10 percent.

 

Social and environmental concerns

The report also noted that “(t)he growth of superstar firms, sectors, and cities also creates policy questions … to include implications for inclusive economic growth that can support and sustain broad-based employment and wage growth.”

This is something to watch out for, as the prospects of tech giants could be determined by environmental, regulatory and social issues. We are seeing the beginnings of a backlash against some tech firms, for instance over personal data use. Social media companies, in particular, are under scrutiny: Facebook was accused of harvesting user data for political purposes during a recent scandal involving disgraced data analytics firm Cambridge Analytica.

The concern that social networks are used as platforms to spread hate speech, fake news or voter manipulation is growing. Several firms have already decided to halt their social media spending amid fears the platforms are increasing divisions in society. A June survey by the World Federation of Advertisers (WFA) revealed that nearly a third of the world’s most powerful brands will suspend spending on social media or are considering it.

“Advertisers and their agencies are extremely concerned by the proliferation of illegal and harmful content on social media platforms. We believe that much more needs to be done to reduce the amount of harmful and divisive content on social media platforms, and we are focused on solutions that ensure that bad actors have as little access to advertiser funding as possible,” said Stephan Loerke, CEO of WFA.

The green record of tech groups is also coming under scrutiny. This could be what prompted Amazon to announce in June the launch of a new U.S.$2-billion venture capital fund in clean tech as part of a Climate Pledge which aims for net-zero carbon emissions by 2040. The group issued 51.17 million metric tons of carbon dioxide last year, the equivalent of 13 coal-burning power plants running for a year.

Consumers increasingly pay attention to sustainability when choosing brands: an August 2018 Nielsen survey revealed that 81 percent of respondents felt strongly that companies should help to improve the environment. In other words, if tech companies do not align their practices and offerings with the mood for change amongst consumers, they could learn a hard lesson.

To conclude with, the COVID-19 pandemic has demonstrated the crucial role of technology in allowing businesses, workers and families to function despite distance. In many ways, the health crisis is only speeding up a movement that was already taking off with digitalisation. However, investors should be wary of complacency in a world where things can turn very quickly and must be discerning and think ahead when picking sectors or individual stocks.

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