Be Fearful When Others Are Greedy – Are Tech Stocks Overcooked?
Our discussion today focuses on the first half of Warren Buffett’s famous quote that it:
Is wise to be fearful when others are greedy and greedy when others are fearful
When discussing this topic, it’s important to keep in mind a few factors. Warren is absolutely a legendary investor and with good reason, however an investor seeking to replicate the Buffett model also needs to remember another of his famous quotes, namely:
Our favourite holding period is forever
Breaking down these two quotes give us a profile of the investor. Warren is a cautious man, focussed on long term results with a behemoth of a portfolio under him. The first comment gives us a contrarian view of the market while the second shows the context within which it is worth keeping a contrarian investment stance. Long term equity investors are looking for dividends and capital appreciation in the form of rising stock prices. These two factors, along with dividend reinvestment are what has led equity markets to be the largest generator of wealth in history and certainly, if you’ve billions at stake, this is a tried and proven way to invest.
But it’s important to remember here that the contrarian viewpoint, despite making large quantities over longer periods of time because assets are being purchased when value realisation is likely to be greater (when others are “fearful” and prices have collapsed), there is a lot of value in the market which the great man himself has missed out on and tech has been one of those big negatives in the Berkshire Hathaway (NYSE:BRK.A) portfolio over the years with Warren famously choosing not to invest in things he doesn’t understand, only relatively recently deciding to jump on the Apple (NASDAQ:AAPL) bandwagon.
Tech Stocks – The Star Performers This Economic Cycle
That headline is actually something of a misnomer. Tech stocks have been the star performers of probably the last 2 economic cycles both pre and post the 2008 financial crisis. Whether your chosen poison has been Intel (NASDAQ:INTC), NVIDIA (NASDAQ:NVDA), AMD (NASDAQ:AMD), Apple, Google (NASDAQ:GOOGL), Facebook (NASDAQ:FB) or others (some of which have now been taken private like ARM and Red Hat), a hell of a lot of value has been created by the technology sector for investors. The question now however is whether the tech market is toppish and this is as much a political question as an economic one in these times.
The argument for the top (or close to, as always, it’s impossible to call tops and bottoms as everyone knows) manifests itself in a few ways:
- Longest bull market run on record
- Numerous global economic indicators slowing
- Mixed US economic indicators (yield curve inversion and loan delinquency vs. job numbers)
- Companies revising expectations downwards
- Nervy markets (Q4 tech collapse)
- Geopolitical tensions (US/China, US/Europe, Brexit, increased middle-east etc)
- The rush to IPO
It’s important to note that as a section, we don’t have a political view on the tensions currently ongoing around the world, but that these kinds of tensions tend to have implications on global trade and therefore on bottom lines. Regulatory red tape for import/export, higher duties and tariffs all hurt a company’s P&L profile.
A long bull market alone is not in and of itself a problem, records were made to be broken of course but the question is are they broken naturally just because things are good, or is the party kept going artificially. There is a case to be made that the current market is being overly propped up by political interests. Tax cuts, influence on central bank interest rate policy, massively expanding government balance sheets and ceasing (yet again) to fully unwind central bank balance sheets from previous QE rounds around the world face the danger of combining with a lack of higher interest rates to leave world governments and central banks with little ammunition in the tank in the event of a global economic downturn.
China is still being touted as a significant driver of global growth (one only has to look at Nintendo’s (TYO:7974) stock jump after it announced a partnership to get the Switch into China), but Chinese growth is slowing, probably both as a result of the trade war as well as due to its own economic cycle. Economic data out of China that is real is hard to come by and many suspect that when Chinese growth official numbers dip to low single figures, the country may actually be in recession. Several company downward revisions in earnings point to China which is probably a combination of over-optimism on the part of the companies as well as falling demand in China itself.
The rush to IPO however is one of the key components of concern. There are legitimate reasons to IPO for many companies at given times of course and it may be that these companies are just at a stage in their evolutions where now is the time that makes most sense but it’s also worth keeping in mind that an IPO at the height of a booming market is likely to yield higher returns than an IPO after an economic collapse. Capital raising needs to occur by firms all the time and an IPO is just one form of capital raising. Some investors have already been bitten (yes I’m looking at you Lyft NASDAQ:LYFT) but it’s good to see that the market has not gotten so carried away with itself that fundamentals are completely overlooked in the rush for the next big thing (now one of the most heavily shorted stocks in existence, if not the most).
Fundamental valuation components of companies such as how much money they make and how much they can expect to grow over the longer term however are not the only driver of stock market returns and although there are several signs that may be worrying people like Warren, it’s also important to note that there are shorter term gains to be achieved for those with a more modest investment portfolio and a holding period shorter than “forever”.
Yield curve inversion is a historically reliable pointer to coming economic turmoil but it is often the case that the portent of doom is overplayed. The US treasury yield curve inverted in 2005, 2006 and 2007 before the 2008 collapse so it’s not like it’s a dead cert that a yield curve inversion means an immediate economic collapse, it’s just one of a number of factors coalescing together which say “warning!”.
The overarching theme at the moment is that US – China trade relations and the US government’s desire to keep the party going are likely to dominate the short term economic landscape. While there is no major turmoil, markets should continue their surge towards IPOs and tech investment but the market definitely feels like it’s approaching a peak.
Value is still there to be had in the tech stocks business but warning signs like Q4 point to nervousness in global investors and institutional investors still form a huge amount of directional flows into or out of equities. These investors will not hesitate to dump in the face of a collapse and move into safe haven asset classes when the time comes. If you’re holding period is forever, this may not be a problem but if you’re relying on the market for regular returns, whether in retirement or saving towards it, the time to be fearful may be approaching.
Tech, having been one of the primary beneficiaries of the bull market run may be more susceptible to a correction than other sectors and it’s worth keeping in mind a quote from another titan of finance, Alan Greenspan in his concern during the dot-com bubble of the nineties referred to the “irrational exuberance” of asset values. That time may be upon us again soon.
Technology today is in a place where it is less the luxury market that it used to be and although not a staple good, is unlikely to be hurt as badly as pure luxury good companies given the degree of technology that we all rely on in our daily lives these days, however the average consumer spending profile on technology is still likely to reduce in the face of economic adversity whereas it won’t on staple goods so there is still risk.