'Old tech' shows it still has bite for investors

A good year for established names creates a headache for active managers.

  • By Robin Wigglesworth,
  • Financial Times
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Last week Microsoft (MSFT) bagged a highly sought-after $10bn cloud computing contract from the US Department of Defense, a huge win for a company that many had written off in the competition against Amazon (AMZN). 

Although there may have been other factors in Microsoft’s victory — President Donald Trump reportedly lobbied against Amazon due to its founder Jeff Bezos’s ownership of the Washington Post — it symbolised a revival of fortunes for some of tech’s old guard, which has been mirrored on the stock market.

The post-crisis bull market has been dominated by technology stocks, and especially fast-growing, glamorous names like Facebook (FB), Amazon, Netflix (NFLX) and Google (GOOG). The astonishing run of the four original “Fang” stocks became emblematic of the longest stock market rally in US history. This year, these high-fliers have been brought back a little closer to earth.

The New York Stock Exchange’s Fang+ index — which also includes Apple (AAPL), Nvidia (NVDA), Tesla (TSLA), Twitter (TWTR) and China’s Baidu (BIDU) and Alibaba (BABA) — has underperformed the wider US stock market over the past year. While these glamour growth stocks have enjoyed solid gains, this is quite a contrast with the past decade, in which they have thrashed almost everything. “Fangs are suffering from being over-owned and over-loved, and several are now facing regulatory problems,” said Jim Paulsen, chief investment strategist at The Leuthold Group. “They’re now the new financial companies, having to testify to Congress.”

Over the past five years the S&P 500 (.SPX) has climbed 51 per cent, while the Fang+ index has risen 184 per cent. Yet even after a recent autumn rally, the Fang+ members remain down 1.1 per cent over the past six months, while the S&P 500 has vaulted to a succession of new highs.

Some of the “old tech” royalty have defied their somewhat dowdy image and actually lately outperformed the Fangs. Microsoft is the posterchild of this shift, with the defence contract win extending its rally to more than 42 per cent so far this year, while Amazon has tracked the broader stock market and gained about 20 per cent. 

The four original “Fang” stocks have generated average 23 per cent total returns this year. An “old tech” trinity of Microsoft, Intel (INTL) and Apple have returned an average of 42 per cent, noted Christopher Harvey, a Wells Fargo strategist. Despite this, the Fangs still trade at almost twice the price-to-earnings ratio of their older peers, reflecting investors’ growth expectations.

“Old tech has been an opportunity hiding in plain sight,” Mr Harvey said in a note last week. “These three stocks have been chronically under-owned because the average large-cap portfolio manager no longer considers them ‘growth’ companies.”

Apple’s recovery this year — which has helped it reclaim its crown as the world’s biggest company by market capitalisation from Microsoft — has proven particularly painful for many fund managers.

Mr Harvey pointed out that Apple represents 3.85 per cent of the S&P 500, but has an average 1.3 per cent weighting among traditional stockpickers. The company’s mammoth 63 per cent rally in 2019 has therefore alone contributed to 0.45 percentage points of the underperformance of active managers this year, he estimates. The analyst reckons Apple’s rally has further to run, given that it will probably pressure some fund managers to start buying to avoid diverging too far from their benchmarks.

“The aversion to ‘old tech’ has created an opportunity, and non-consensus investors have been the beneficiaries,” Mr Harvey said. “Yet positioning suggests the opportunity has not been closed out.”

There are echoes of this internationally, among older and well-established tech names. Germany’s SAP (SAP), Dutch semiconductor maker ASML (ASML) and Japan’s Keyence (KYCCF) have returned 40 per cent, 78 per cent and 33 per cent respectively — comfortably beating the broader market, said Nicholas Colas of DataTrek. Meanwhile, China’s equivalent of the Faangs — Alibaba, Tencent (TCEHY) and Baidu — have seen mixed performance.

The new-against-old tech dichotomy is hardly clean-cut. Nor should the trend be overstated. Investors have favoured solid, defensive stocks this year — given the dimming global economy — but remain in love with companies that look like they can deliver strong growth rates almost irrespective of the economic backdrop. 

While Apple and Microsoft have done well, other classic “old tech” stocks, such as IBM (IBM) and Oracle (ORCL), have only tracked the broader market over the past six months. Facebook has trounced it, in spite of the increased public and regulatory scrutiny, and Intel has only recently started to catch up. 

Wayne Wicker, chief investment officer of ICMA-RC, a pension plan manager, argues that the recent dispersion comes down mostly to the performance of individual companies. “IBM is the epitome of old tech, and hasn’t done well lately,” he points out. “Some people have just navigated the environment better or worse than others.”

Nonetheless, with elevated valuations in Fang stocks, and indeed in stocks more broadly, some fund managers are understandably skittish. Mr Paulsen argues they should examine the “mini-Fangs” in the S&P 600 small-cap technology index (.SML) — stocks that are too small to qualify for the blue-chip large-capitalisation S&P 500. He thinks they offer better long-term potential and short-term protection against a market wobble. 

“They have a much faster long-term growth rate, they’re under-loved and under-owned,” he said. “And they’re not in the crosshairs of regulators.”

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