Taking the analysis to the corporate level is even more revealing. Many investors choose to put their money in so-called defensive consumer staples companies. The appeal is simple: people will surely keep drinking Coca-Cola and buying Gillette razors (Proctor & Gamble, P&G) regardless of wider economic changes so investors surmise that this is a safe home for their money. Yet the earnings prospects for these companies are often far beneath those of similarly valued technology companies as shown by Figure 4.
Figure 4: Consumer staples v technology
Source: Bloomberg Consensus Estimates, 14 June 2017. Forecasts are estimates only and are not guaranteed. FY= financial year
In fact, technology is facilitating the disruption of many of these traditional companies. Dollar Shave Club – a business set up to sell cheap razors directly through the post to households – is disintermediating traditional retailers and undercutting established players. P&G admitted that part of its revenue miss in its most recent results was due to more intensive competition in the grooming segment, where sales were down 6%. Whether it is Amazon disrupting retailers, Purplebricks disrupting estate agents, or Google disrupting traditional advertising and media, the continual drum-beat of profits warnings from many areas of the old economy are a testament to this process.
What is driving these share gains? In a word: innovation. At the base of all electronic technology is the integrated circuit. Since its invention in 1958 we have been able to cram more and more processing power into less space at a lower cost. This phenomenon (known as Moore’s Law after one of the founders of Intel who first predicted this trend) enables the doubling of speed, halving of cost or halving of size of a semiconductor every 18 months. New products become possible, and existing products get cheaper and better. This is why the feature phone you had ten years ago is unrecognisable from the smartphones of today. It is very difficult for other industries to compete against this trend, driving these technology share gains.
The biggest threat to technology is perhaps the one that faces the entire market – can equities cope if central bank liquidity is withdrawn? In this regard, technology can sometimes be a victim of its own success. In any sell-off it tends to be the first to respond, for the simple reason that investors typically sell things that have done well to bank a profit – as was the case in the most recent market reversal. However, it is our view that the long term secular trends are so strong that on a relative basis at least technology will continue to outperform other equities in the medium to long term.
While technology might be viewed as one sector among many by investors, it is having a transformative role in shaping the modern economy. Its capacity to generate earnings, capture market share, or facilitate that capture by non-traditional companies, is something that we view as structural and for that reason alone is worth considering for any investor portfolio.