COVID-19 has flipped everyone’s sense of a normal life on it’s head. It didn’t forget about the stock market either.
After a prolonged period of steady growth and one of the longest bull market runs, we plunged into one of the fastest bear markets in history in mid-March. June 30, 2020 ended the greatest quarter of the market in 20+ years!
But this wasn’t a normal run up in the market. Many companies and sectors that decreased in value in March and April didn’t bounce back in May and June. Many have been extremely volatile. And many just shot up and haven’t looked back. These are the businesses I want to discuss and almost all of them have one thing in common: THEY ARE CENTERED AROUND TECHNOLOGY
A BRIEF HISTORY LESSON
In the mid-1990’s the internet became available across the developed world as a way to communicate and share information. This was a huge inflection point in the way the world worked and technology stocks of all sizes took off… only to fall flat on their faces in the early 2000’s in what is known as the dotcom bubble. The tech-heavy centered Nasdaq Index cratered and many internet companies went belly up.
The simple answer as to why this happened is there was a lot of money invested in small start-ups that probably never had any hope of turning a profit. Why not? Because even though most of the world was using the internet there was not enough infrastructure and usage of it to justify the crazy stock prices of these companies. Put simply, the world wasn’t ready yet. Many businesses that these new technologies were created for still held a competitive advantage by doing things the old way. There was no need to invest in expensive technologies to survive. There was no need for digital marketing. The average household that used the internet wasn’t using it for e-commerce, social media, or many of the things we use it for today. It was largely just an email channel.
This all changed in the mid-2000’s. What happened? Many things happened, but we had another inflection point that involved the internet becoming more of a mainstream tool in our corporate and personal lives. Facebook popped up on the radar of every college kid in America, the visionary Steve Jobs persevered and gave us the iPhone, Amazon realized that they could sell way more than books over the internet, Netflix found that people loved having DVD’s shipped to them via mail, and Google started raking in money from digital advertising. The FAANG was born!
These companies (and others along with them) created a need that wasn’t recognized during the dotcom bubble. They all found high demand products and services that consumers were ready to adopt. It just took a little time for the world to embrace the internet and all it had to offer. Since that time in the mid/late 2000’s technology has taken off and has been a fantastic place to put your investment dollars ever since.
THE MAIN EVENT: VALUE VS GROWTH
Many experts feel that value stocks are the best places for your money to get great returns. Value stocks are those that trade at a price that is low to the fundamental value of the company and have a low Price/Earnings (P/E) Ratio. The staples of value investing tend to be dividend paying companies with strong foundations (think financial companies, healthcare, infrastructure, energy, and utilities). There are some good value buys out there and I believe that a diversified portfolio is one of the best ways to lower volatility and reduce risk. But, if you’re looking to the future and where the best investing opportunities are, we need to re-define the term “value.”
Why can’t a company be a good value even if it has little to no earnings? If a company is dominant in its market, has a way to monetize the market, and is reinvesting heavily in its growth I think it would be one to take a look at. There are many technology companies out there that haven’t come close to realizing their potential growth. In fact, some of the FAANG companies weren’t profitable when they became public companies. Growth stocks are typically identified as those that are anticipated to grow at a rate quicker than the overall market.
There are many ways to compare value to growth over the years. I’m going to use the iShares Russell 1000 ETFs for those respective indexes. IWD for Value and IWF for Growth. A simple comparison of the two shows massive outperformance for the growth ETF over the past 5, 10, 15, and 20 years. You’d have to go back to the time of the dotcom bubble to see a narrowing of the returns.
The fact is technology has taken over our society and it’s not going anywhere. More and more of today’s college graduates and youth are caught up in learning, adopting, and innovating new technologies. New and innovative companies are eating into the market share, revenues, and profitability of their competitors (look at Netflix vs. Blockbuster as an extreme example).
Another viewpoint is that the value staples mentioned above are adopting technology to further grow their businesses. Every major bank has an app, hospitals are performing robotic surgeries, communications companies are racing to adopt 5G, real estate is being used to house powerful servers, and on and on. There is more tech innovation in non-tech parts of the economy than ever before.
I absolutely believe it’s important to diversify your portfolio, especially as you approach whatever goal you’re saving for. I also believe that the world is innovating at a rate not seen since the industrial revolution… and it’s not going to stop. You may have heard the terms 5G, SaaS (software as a service), TaaS (transportation as a service), IoT (Internet of Things), the cloud, AI (Artificial Intelligence), and Blockchain. These “new” technologies were born out of necessity. Some are more developed than others and some may take years to fully materialize. The point is they’re here, they’re not going away, and the next tech innovations are right behind them.
Technology is also making the world a better place in many regards. Amazon just announced a $2 Billion dollar sustainability initiative. Facebook is leading an effort to build an underwater cable system around Africa to help bring the internet to a continent that has lagged behind more developed nations in the adoption of modern technology. Many new startups have goals to reduce carbon footprints and leave a better world for the next generation.
THE EFFECT OF COVID-19
So why now? Why did COVID-19 seem to be a catalyst for Growth and Tech investments to take off? As I showed earlier with the growth vs value comparison, this has been a trend for a number of years. COVID-19 didn’t create the extreme growth trends we’ve seen since the market bottomed in mid-march. What it did is accelerate them and expand the breadth of them. Our society now has the infrastructure (high speed internet, smart phones, video-conferencing) to overcome the economic impacts of a virus that seemingly has taken over the world. We would be in a very different place economically had COVID-19 happened 20 years ago. The technology simply wasn’t there for a rapid recovery.
This virus will be with us for a while. Once we have a vaccine it will take time to mass produce it and distribute it to the world. So, we need to embrace the “work from home” environment and continue to live our lives with a little more caution out in public. New companies will be born out of our new world and they will thrive. I believe that COVID-19 will lead to even more innovation and most importantly more collaboration between engineers, scientists, and companies to develop the next “thing” that society can’t live without.
Many experts will argue that the prices of growth stocks have gotten too high. I think generalizing that statement is a mistake. There are many companies that look expensive on paper and many that don’t. Some of the “expensive” ones are that way for a reason and they still present a good value. They are expected to grow and grow rapidly and these expectations are there because they are pioneers paving the way for a better tomorrow. Jumping on the train after it’s left the station isn’t always a bad thing when it comes to tech and growth investing.
WHY NOT GO ALL IN ON GROWTH AND TECH?
Many advisors believe that diversification is a key factor in mitigating risk in a portfolio. I am one of them. But I also know that a few poor investments can weigh a portfolio down. Take the S&P 500 index as an example. It comprises the largest 500 publicly traded companies in the United States. The SPY ETF tracks this index and the largest sector in it is: Technology! However, there are 10 other sectors in the S&P 500 and many of them have caused the index to lag behind the tech heavy Nasdaq index (the ETF is QQQ). There are ways to be diversified without the diversification dragging down your portfolio over time. The Nasdaq index has substantially outperformed the S&P 500 since the financial crisis.
Both indexes have value and growth style companies in them. However, in this time of COVID-19 you probably want to limit exposure to real estate, airlines, hotels, and other sectors that aren’t positioned to do well or may be more volatile as we figure out the pandemic. You cannot do that by investing in the broad based S&P 500. The Nasdaq also has companies in these sectors as well, just not as many of them.
This COVID-19 market is great for those that can select individual stocks and weed out any exposure to highly volatile sectors and companies. For the value diversification in your portfolio look for companies that have continued to increase their dividends and avoid those that have cut them. They are typically the strongest financially and will be better suited to withstand any long-term wounds from COVID-19.
One of the biggest caveats to investing in growth and technology is to diversify within the space itself. Technology can be found in many different spots like real estate, hardware, software, and the cloud. Hold positions in different types and sizes of companies and if one becomes too large a percentage of your portfolio (I use 10% as a benchmark depending on your time horizon) then sell some of it off. Remember though, oftentimes your biggest winners continue to grow and offer greater returns. If you don’t feel comfortable picking individual stocks, find some growth and technology ETFs
Growth stocks have proven to be more than a short-term trend. Innovation in the technology space is the new norm in a world that continues to offer the infrastructure to support it. Every generation born from here on out will be born into a world where technology is at the forefront. Why not take advantage of it inside our portfolios?
In my opinion the overweighting of value stocks has run its course. Growth has shown its resiliency and is here to stay. You may have a little more short term volatility from year to year, but with a long time horizon I believe it is the way to outperform.
If you’d like to talk more about my investing philosophies and how I invest my portfolios for the long term, schedule a call with me here.
Disclosure
Sean Gerlin owns shares of Apple, Amazon, Netflix, and Google. This article should not be taken as investment advice or guidance. Do not buy or sell stocks based solely on the content provided.