Global Market Perspective
Dotcom crash: 20 years of hindsight
In January 2000 global stock markets stood on the precipice of a crash that was set to obliterate both fortunes and reputations. During the late 1990s, amid a frenzy of speculation, investors and day traders were lured into hot “TMT” (technology, media and telecom) stocks – including numerous new businesses yet to turn a penny in profit. At the turn of the year 2000, the “dotcom” bubble burst and shares crashed. In the UK, the episode dealt a heavy blow to the culture of individual share ownership.
Looking back, however, the past two decades have shown that many of the insights of early internet investors were fundamentally correct – even if their timing was way off the mark. No-one today would dispute the fact that the internet has transformed the way we live and work.
At the time, internet pioneers were ridiculed for their focus on attracting “eyeballs” and building market-leading positions – at the expense of revenue and profits. Yet that has been a winning strategy for many of today’s biggest internet companies – such as Facebook and Netflix. Similarly, after the crash, the idea of looking beyond sky-high valuation multiples and buying into long-term growth was frowned upon. Yet it has paid off in spades more recently. Amazon, for instance, traded at a forward price/earnings (P/E) multiple of 80 a decade ago and was a no-go area for many stock pickers. It has since increased in price more than ten fold.
Of course, amid the “irrational exuberance” of the late 1990s, many companies and investors had completely unrealistic expectations about the speed of online adoption. Even today, just 11% of US retail sales are online, according to the US Census Bureau .
Many companies – including notoriously short-lived businesses such as Pets.com – were doomed from the outset by huge advertising spending and flawed business models. Others – such as Lastminute.com in the UK – simply didn’t fulfil the promise baked into their lofty share prices and ended up as far smaller companies, or drifted into obscurity.
But for the few technology companies that did get it right, the subsequent growth and scale of earnings have been phenomenal.
Take Google, which was founded in 1998 and already a leader in search when it floated in 2004. Its market value at that time was $23 billion. Given the still fresh scars of the dotcom bust, many investors were understandably wary of a business that was valued at an eye-watering earnings multiple of around 60. However, Alphabet, as it is now known, has an unassailable position in internet search and used this to create a hugely profitable business. Its earnings have risen to an astonishing $30 billion and its valuation approaches $1 trillion.
This incredible growth tells the story of technology over the course of the past two decades. Not all of the world’s technology companies have achieved what Google has. Yet, in aggregate, the earnings of global tech companies are over three times higher than they were in 2000. By comparison, the sector's prices are just 35% above the dotcom peak (see below). The combination of booming profits and modestly higher prices means that valuations have fallen dramatically. In fact, the valuation of the technology sector today looks reasonable, on a forward P/E of approximately 21 times earnings. This is slightly higher than the average for equities globally, but it is understandable given the sector’s still attractive growth prospects.
The journey back to dotcom highs has been long
MSCI World Technology Index vs. MSCI World (USD, rebased to 100)
Source: Refinitiv Datastream, December 2019
Back in 1999, three of the five largest companies in the US were involved in technology (see below). Today, all of them are, with Microsoft featuring both then and now. Its dominance in desktop computing led it to the top of the ranks in the late 1990s; today it is its position in cloud computing that makes it one of the world’s most highly prized companies. Tellingly, the worst performer of the 1999 cohort comes from outside the technology sector: GE has lost some 80% of its value over the past 20 years. The company has made strategic mistakes, but its plight is also symptomatic of a changing investment environment. Businesses with big balance sheets and huge investment requirements look much less attractive than those based on brands, knowledge and technology. One key appeal of these latter businesses is their “scalability”: once an app has been developed, for example, it can be downloaded countless times without incurring much additional cost.
America's largest companies: then and now
Company market value ($ billions)
Source: Refinitiv Datastream, December 2019
The decade ahead
There is good reason to believe we may still be in the foothills of a tech spending boom. In many areas, adoption of new technology is still in the early stages. Cloud computing is a good example. The cloud allows businesses to take their IT “out of the basement” and access the services they need online, at lower cost and more efficiently. Yet only 20% of large global firms have made the switch so far, according to a recent study. This suggests that for industry leaders Amazon and Microsoft it will be a source of growth for years to come. Looking further ahead, developments in artificial intelligence also open up huge opportunities.
In the UK, for example, there has long been a shortage of medical staff able to interpret scans: AI is ideally suited to this kind of pattern-spotting work and trials of its use in this context are already under way.
Unsurprisingly, technology plays an important role in many of the key themes that our equity specialists are thinking about – as summarised in the table below.
One such theme is the internet in Asia. China already has more than twice the internet users of the US. Given its huge population, this represents a still-low adoption rate of just 56%. As the US and China tussle over trade and technology, we expect China to increasingly turn inwards as its online ecosystem continues to develop. This shift will create new tech winners in the years ahead.
Though tech sector share prices have done incredibly well in recent years, we think talk of another bubble is misplaced. The sector today looks very different from what it was 20 years ago – or even a decade ago. It is now a fertile hunting ground for exactly the kinds of businesses we want to own: well-managed, profitable companies with attractive growth prospects.
Seven themes for the next decade
The technological transformation of our lives over the past 20 years is reflected in the biggest themes which we think will shape the decades ahead. The following seven themes, developed by Cazenove Capital’s equity specialists, form the cornerstone of more detailed ongoing research.
|Theme||What's happening?||Why?||Investment Considerations|
|The 30-year trend towards freer movement of goods, people and capital is
starting to reverse.
|Globalisation has not been good for
everyone. It has contributed to inequality
and the rise of populist politics.
|- More protectionism could impact on
- Focus on “capital-lite” businesses
|Climate change||The world is getting warmer. The 20
warmest years on record occurred in the
last 22 years. Extreme weather has led to
large scale displacements.
|We have not been reducing emissions
fast enough to reduce climate change.
China (29%) and the US (14%) are the two
|- Markets start to properly price emissions
- Better disclosure
- Focus on companies that can benefit
from a circular economy
|Increasingly, the US, China and Russia are
developing their own internet ecosystems
and closing them off to outsiders.
|The trend is motivated by security
concerns as well as commercial
|- Trade war turns to tech war
- Greater share of tech infrastructure
- China has 2.6 times more internet users but
only 56% penetration. Look East not West
|Monetary policy has been great for stock
and bond markets over the past decade…
but investors should expect less from it in
|Even central bankers now admit that
monetary policy is nearing the limits of
what it can achieve.
|- Higher market volatility
- Renewed focus on government spending
|Demographics||For the first time in history, there
will soon be more people aged over
65 than under five.
|Increased life expectancy and falling
|- Changing consumption patterns
- Welfare worries: the digitisation of health
- “Youth quake” spending vs the “grey pound”
|"Stakeholders not just shareholders"||We expect companies to be more
accountable. Regulators and big investors
are taking note, requiring companies to
improve working practices and disclosure.
|- Focus on sustainability and accountability
- Rise of long-term thematic investment
|"Rise of the machines" and
|Step change in technology infrastructure
and “datafication” of everything
|- Platform companies
- Quantum computing
- Productivity and margin