Is the tech sector in need of a reboot?

Technology stocks have dominated financial headlines recently, following social media giant Facebook’s recent fall from grace.

Having led the US stock market to all-time highs, the sector enjoyed returns of 26.73% during 2017 alone*, before the exposé of elections consultancy Cambridge Analytica’s use of the company’s data to attempt to sway 87 million political votes in mid-March. This caused Facebook shares to fall by approximately 10%** since the scandal hit to time of writing, and has had a knock-on effect among other tech stocks too.

Technology has always captured the imagination of investors, especially as it touches so many areas of our lives. But at the same time, change – and fast-paced change especially – can be scary. Will robots take over our jobs? How closely is “Big Brother” watching us?

As questions are raised regarding Silicon Valley’s ideology and companies’ social and political responsibilities, can the market area’s strong performance keep pace as regulatory pressures increase?

A clamp down in regulation?

According to a recent report from Bank of America Merrill Lynch, technology is the least-regulated industry sector. It currently has ‘only’ 27,000 regulations compared to 128,000 for the financial sector and 215,000 for manufacturing***, for instance.

As we have seen from both banks and tobacco companies in the past, regulatory tightening can lead to substantial fines and more red tape, so it is understandable that the sector has experienced market wobbles of late.

But before investors make any rash decisions, it is always worth noting that any swings in market sentiment can open up buying opportunities, depending on circumstances.

A bursting bubble or a buying opportunity?

Jeremy Gleeson, manager of the Elite Rated AXA Framlington Global Technology fund, does not believe we are in a tech bubble because, while the sector has outperformed the broader market over the last decade, it has been supported by strong revenues, earnings and cashflow growth. As such, he doesn’t believe valuations are stretched.

“Facebook’s recent stock sell-off has been driven by the belief that the negative headlines may result in large numbers of users closing their accounts. We think this is unlikely and back the management team to be able to resolve this issue,” Jeremy told us. “We will of course be monitoring developments, but we believe that the medium term trends supporting the investment case for Facebook remain intact.

“The return on investment that advertisers get on Facebook is much greater than on traditional media such as TV. We don’t think advertisers will make any dramatic changes for the moment, there are not many efficient alternatives combining personalised digital marketing solutions and a huge user base. If the company is fined, we believe Facebook has enough cash reserve to withstand the hit.”

How can the tech sector progress from here?

BlackRock’s global chief investment strategist, Richard Turnill, said the tech sector’s decade-long bull run is now facing a test. Given that it accounts for large chunks of most developed equity markets, he pointed out that the sector would be left vulnerable if investors suddenly decided to cut risk. However, Richard expects “robust” demand growth for tech products and services to continue.

“For example, semiconductor makers are well-placed to benefit as a wide swathe of industries incorporate chips into their products. Mega-cap tech companies geared toward enterprise spending are also benefiting from an increase in demand,” he explained.

“The tech sector lagged its peers following the US tax overhaul because it had one of the lowest tax rates already. But our analysis suggests that companies from other sectors are looking to deploy their tax windfalls on tech spend, which could indirectly benefit the market area.”

According to Polar Capital Partners, there are also several other catalysts which should keep feeding the growth of the technology sector. These include a fourth industrial revolution, sparked by greater connectivity between devices, vehicles and home appliances; and increasing demand for labour, which should bring robotics demand into the mainstream and increase human-robot collaboration in the workplace. In fact, they predict that only 6% of jobs will be lost to automation.

Meanwhile, the team at Smith & Williamson already uses artificial intelligence technology to automate part of the fund’s investment process, and believes it will become more commonplace over the years across industries.

The management team said: “What we care about is the long-term growth opportunity presented by artificial intelligence and the knowledge that it is likely to be as transformational as the railways or telephone – and perhaps more so, particularly in areas such as healthcare.”

*Source: FE Analytics. Total returns of Nasdaq 100 Technology Sector index in sterling terms. Data correct to 11 April 2018.

**Source: MarketWatch. Data correct to 11 April 2018.

***Source: BofA merill Lynch report, 8 April 2018.