The tech sector’s impressive performance and increasing concentration in indexes has led to concerns of expensive valuations—with some fearing that we could be in bubble territory. In our view, such worries are not justified, and we believe tech’s outlook remains healthy.
The technology sector is undeniably shaping up to be one of the front runners coming out of the current crisis. The sector has been widely covered by the media, with recent headlines drawing attention to tech’s market-leading performance, high concentration in benchmark indexes and, by some accounts, expensive valuations—with some market commentators going so far as to claim we could be in bubble territory.
This creates the impression that the market has potentially run too far, and that technology is once again to blame. In our view, this is an oversimplification—indeed, the devil is in the details, and unpacking these statements is key to figuring out what is really going on.
The MSCI All Countries World price performance over time, as well as for the constituent sectors, indeed shows that tech has led the market. In fact, the proportion of market cap that is accounted for by the 10 largest companies is now at levels not seen in recent times, and is a source of much angst in the business media given that the list is dominated by technology and internet companies1.
We would note, though, that this analysis stops short of fully understanding what is really happening. The simplest rebuttal is to note that during 2020, the impact of COVID and the subsequent recessionary impact on specific sectors of the market has meant an underperformance of the financials and energy sectors, as well as many smaller companies— which has shifted the index makeup much more toward the larger-cap technology and internet companies. Note also that the concentration of the enterprise values of the top 10 index constituents is far less severe, as their balance sheets are extremely healthy and give comfort that share buybacks can increase if these companies need to support their share prices.
1. September 2020 top 10 constituents of the MSCI ACWI = Apple, Microsoft, Amazon, Facebook, Alibaba, Alphabet, Johnson & Johnson, Tencent, TSMC, Nestle. December 1999 top 10 = General Electric, Exxon Mobil, Pfizer, Cisco, Citigroup, Walmart, Microsoft, AIG, Vodafone, Merck.