Big tech in 2020: a winning contrarian approach?

Most stock market peaks are followed relatively quickly by another. In fact, the US stock market has ended 5 per cent of all trading days in its history at a higher level than ever before, and in 2019 claimed a new peak on average once every two-and-a-half weeks. 

But occasionally the market will hit a ‘true peak’ – a high that is followed by a long period of declines and a painful return to previous levels. Nine years and 10 months separated two peaks in the Dow Jones in the 1970s and early 1980s, and investors waited nearly seven years for the market to regain its previous high after the dotcom bubble burst in early 2000. As we enter a new decade, the question is pressing: will 2020 bring with it another ‘true’ market high and miserable sell-off?

Doomsters predicting the end of the current US bull run have been growing in number as the market has matured. 2019 was meant to be the year the run of peaks came to an end (after all, it began on a bleak note following the market blip in the final quarter of 2018), but we’ve hit 19 all-time highs to date, one more than last year. And just like 2018 and 2017 (when the US stock market peaked a whopping 62 times), investors can thank the tech sector. 

The enduring health of US tech is therefore a crucial consideration for investors speculating about the direction of the market next year. In 2020, these companies are facing perhaps their biggest challenges for a decade. After all, growth stocks can’t keep accelerating forever.

Hunting for value

Similarly, it could also be said that underperforming shares can’t stay unloved forever. Value investing has had a terrible decade as investors have gravitated towards the thrill of tech and innovation, while low-growth, cyclical and defensive stocks have been wildly unpopular. But in the past few months, a slowdown in global economic growth has reminded investors of the value of value – US value stocks have gained almost 10 per cent since the beginning of September, more than three times the total return of US growth stocks. 

Leading US tech companies are hard to value based on traditional metrics 

Source: FactSet

Value is almost impossible to come by in the tech industry and eye-watering valuation metrics are frequently pointed to by the sceptics of continued momentum who make alarming comparisons with the dotcom boom and bust at the turn of the millennium. Sky-high price/earnings ratios make it all too easy to think of Alphabet (US:GOOGL), Amazon (US:AMZN) and Netflix (US:NFLX) as new-age tech pioneers, hyped up on a bull market that has embraced innovation but given little thought to sensible investment fundamentals. But these companies are not like the ones that created the dotcom bubble; they are all highly profitable, cash-generative and capable of generating significant growth even through turbulent times – all three have already endured two market crashes.

The same is even more true of the likes of Adobe (US:ADBE), Apple (US:AAPL) and Microsoft (US:MSFT), which have continued to innovate and grow for the best part of five decades. When a $1 trillion company reports year-on-year revenue growth of 14 per cent (Microsoft) or $922m of quarterly operating cash inflows from $854m of operating profits (Adobe), it is quite easy to make the argument that a 30-plus price/earnings ratio is not unreasonable. 

Beware regulation 

But a problem with the wide protective moats that make investors confident in sustained profit growth from these tech giants is that they have also given these companies huge influence in society. And that is making regulators twitchy. 

For example, Amazon has been compared to the railways of the Progressive Era, which were tightly regulated under the 1906 Hepburn Act. “The thousands of retailers and independent businesses that must ride Amazon’s rails to reach market are increasingly dependent on their biggest competitor,” wrote Lina Khan in her game-changing Yale Law article ‘Amazon’s Antitrust Paradox’. Ms Khan is a big advocate of a clampdown on big tech: “We need a new framework, a new vocabulary for how to assess and address their dominance,” she says.

Her ideas have been picked up by some of the loudest political opponents of corporate dominance. In Europe, Margrethe Vestager – until this month the European Commissioner for Competition – has whacked Google with a $9bn fine for breaking antitrust laws and forced Apple to pay roughly $14.5bn for avoiding taxes. From her expanded role in charge of antitrust and digital policy in the EU, she is considering removing some protections that shield internet platforms from liability for content posted by users and is working on a new policy to make US tech giants pay more tax in Europe. 

France has brought in its own tech tax, which imposes a 3 per cent levy on companies that generate at least €750m of revenue and digital sales of €25m in France. Most of the 30 affected companies are American, which has drawn the ire of Donald Trump, who appears happy to pull out all the stops to keep pushing the markets higher. In retaliation for the tech tax introduced in France, he has proposed 100 per cent tariffs on up to $2.4bn of French goods. The EU has promised subsequent retaliation, and further escalation of the trade tensions has created an unwanted aura of uncertainty for the tech sector as we head into 2020.

Meanwhile, Mr Trump is facing growing pressure to clamp down on tech dominance from voices in his own country. Elizabeth Warren – his likely opponent in the race for the White House in next year’s presidential campaign – says she will separate ‘search’ from the rest of Google, split Amazon’s third-party marketplace from its division of in-house retail brands, and roll back many of the major tech acquisitions this decade, if she wins the keys to the White House in 2020.  

The pressure is especially heavy on Facebook (US:FB), Twitter (US:TWTR) and Snap (US:SNAP), which have no back-up plan if their current source of revenue growth and extraordinary profits – advertising – is regulated. With consumers joining in the calls for tighter scrutiny of the use of data in social media advertising, these companies could be in trouble. Indeed, Citigroup’s new Facebook analyst recently warned that the long-term regulatory threats could shave 30 per cent from the company’s current value. 

Tighter regulation is also a pressing issue for some of the so-called unicorns – start-ups that have claimed a valuation of over $1bn. As we wrote in our June feature ‘Cancel the Unicorn Hunt’, many of these companies are having a similarly influential impact in society as their older tech cousins and this is drawing the criticism of the regulators. Uber (US:UBER) and Lyft (US:LYFT) for example, are facing calls to class their drivers as employees, which would add unpayable costs. Airbnb – which is one of the hottest IPOs planned for 2020 – has faced criticism for its role in changing city dynamics. A clampdown on its presence in certain locations could hamper growth prospects.

Competitive China

For some, the threat of regulation is not nearly as pressing as the burgeoning competition from China. Apple, for example, is enduring a very high-profile battle for phone customers as Huawei expands across Europe. In 2019, the US group stopped reporting individual sales volumes of the iPhone as price growth (rather than rising demand) began to drive revenues of the flagship product. In 2020 it will rely more heavily on its software and services business to drive revenue growth – not necessarily a bad thing considering the impressive margins of this division. 

Unlike Apple, Amazon hasn’t yet reported any direct hit to its revenue growth from Chinese peers, but it has taken steps to mitigate the threat of competition. In early 2019, the company shut down its Chinese domestic e-commerce business after giving in to competition from the likes of Alibaba (US:BABA) and JD.com (US:JD).

It is worth keeping an eye on global growth at Alibaba – the king of disruptive innovation in retail. The Chinese group has built the world’s fastest cloud-based streaming processing platform, which can manage staggering amounts of data and offer a personalised customer experience which is reportedly miles ahead of Amazon – if it pursues overseas expansion that could put pressure on the previously uncontested US giant.

Be contrarian – stick with tech 

Headlines from big business media reflect a widespread nervous attitude towards the enduring ability of the tech sector to keep driving US market momentum. Positive outlooks are few and far between and if these concerns keep mounting, growth will quickly become a contrarian approach for 2020.

Those seeking reassurance can look to the unlikely source of Elizabeth Warren’s recent blog, titled ‘It’s time to break up Amazon, Google and Facebook’. Here she points to the fact that regulation of Microsoft in the 1990s paved the way for the emergence of the FAANGs: “Promoting competition is so important,” she wrote, “aren’t we all glad that we now have the option of using Google instead of being stuck with Bing?”

This is a strong reminder that regulation, competition and any of the other nasties currently undermining confidence in tech will only impact the companies that aren’t strong enough to withstand them. After all, regulation didn’t harm Microsoft in the long term – in 2019, the software giant reclaimed its title as the largest listed company in the world after a 41 per cent share price leap. As a nervous attitude continues to spread, tech giants with a strong plan for profitable growth over the long term could be a winning contrarian approach for 2020.