The US stock market technically entered bear territory midway through June when the S&P 500 index slipped to 21 per cent below its most recent peak in January. Legend has it that the use of the term ‘bear’ to denote a market downturn has its roots in the 18th-century trade in bearskins. Middlemen in the trade would sometimes arrange what amounted to a put option on bearskins in anticipation of falling prices, hence the proverbial warning that’s it’s not always a good idea to “sell the bear’s skin before one has caught the bear”.
Grizzly derivatives aside, the FTSE 100 has held up reasonably well by comparison, partly a consequence of the domestic index’s energy weighting, but also because of the ‘blue sky’ valuations ascribed to tech stocks across the pond. Consider that between the initial pandemic sell-off through to last November the Nasdaq index rose by 137 per cent. It has subsequently pulled back by a third, mirrored by a step up in short positions on US information technology stocks.
Curiously enough, bear markets in the post-war period have resulted in an average decline of around 33 per cent from the market’s most recent high. Unfortunately, not all those bear markets have taken place when wider macroeconomic conditions have been so challenging. Investors can take some solace in the knowledge that the average duration of bull markets is around four times longer than that of the average bear market, although we should remember that it was years before indices retraced in the wake of the global financial crisis. Then, as now, the withdrawal of liquidity was a source of consternation for investors.
This time around, savvy investors would have taken the view that it wasn’t a case of ‘if’ but ‘when’ tech multiples would start to march back. Although every business is unique and valuations are based on many considerations, it was always fanciful to imagine that the growth in tech funding would be matched by commensurate growth in corporate earnings. A year ago, it was already apparent that tech revenue multiples were in retreat, while cash profit multiples for the sector were holding steady.
Behavioural finance tells us that the same people who rushed in to buy tech stocks when multiples were on the fly are likely to be the same ones unloading their positions as markets click into reverse, crystallising losses in the process. The main market indices have delivered growth rates well above inflation over the long term, but that growth is not linear. It’s not advisable to call a floor on the market, but a bear market gives you the chance to take advantage of lower stock prices before a recovery occurs, particularly if you’re constructing your portfolio based on long horizons.
One tech stock worthy of consideration (or reconsideration) has been with us since 1911. The share price of International Business Machines Corporation (US: IBM), up 1.5 per cent since the end of 2021, provides a stark contrast with many of its more youthful rivals.
Why is this so? Well, it’s partly due to the steady diversification of its product and service offering since the turn of the millennium. The group, once largely synonymous with the production of computer mainframes, is now engaged in activities across the digital spectrum, from cloud, data and artificial intelligence through to consulting, business process and application management services.
IBM’s determination to diversify its business could have been prompted by an earlier failure to anticipate the disruption brought about by the rapid expansion of the personal computer and client-server markets. Whatever the rationale, the diversification strategy has not only broadened the group’s market catchment, but it has also significantly increased the proportion of its recurring revenues. The upshot is that IBM has gradually reinforced its defensive attributes, a point that would not have gone unnoticed as we entered the early phase of an economic downturn.
Market sentiment would also have been improved by news that 2022 revenue growth will be at the high end of expectations. The group reported first-quarter revenue of $14.2bn (£11.6bn), an 8 per cent increase on the 2021 comparator, while income from continuing operations was up by nearly two-thirds to $662mn. Leverage remains an issue with total debt at 2.79 times cash profits, although it has $20.8bn in liquidity at its disposal and is rated at A- (stable) by S&P. Meanwhile, FactSet consensus points to a marked increase in intellectual property income through the year, another defensive attribute, and the stock changes hands at a modest 14 times consensus earnings with an implied forward yield of 5 per cent.
