2020 has been a remarkable year in the markets, especially for the technology sector and the US markets. The recovery for technology companies has brought up the debate again about whether we have a tech bubble or not. If it is a bubble, it is certainly stronger than any we have seen in the past and doesn’t look like it will be bursting anytime soon.
The Benefits of Intangible Assets
In the past, intangible assets would have been a small part of any company’s balance sheet, but as technology companies have grown, intangible assets are now much more valuable. As highlighted in a Bloomberg article, if you take the tangible assets of all the companies in the index, the value of these assets is just under 20% of the index value. This is not entirely surprising as we know that much of this year’s rally in US equities has been driven by the technology sector.
Companies in the technology sector tend to have a large amount of intangible assets. If you take Apple, Microsoft and Google for example, these are companies who in recent years have spent millions of dollars on cloud infrastructure. Cloud computing is becoming more popular across the globe but think about the costs required to set this up. The initial costs to buy servers and setting everything up would be expensive, but thereafter the costs per user are relatively minimal for the company and this is reflected in the subscription costs charged. In a short period of time, the costs are covered but the subscription money continues to flow in. These services eventually start to become invaluable for businesses and they are unlikely to move back towards using physical hardware. Therefore, these types of intangible assets like a cloud service are difficult to value and they go a long way to ensuring continued cashflow for companies during economic downturns.
Have Tech Companies Recovered Too Quickly?
It has been well documented that the historic recovery in US equities this year has largely been driven by the technology sector. In recent months, other sectors are starting to catch up with the global economic recovery underway, but the tech sector continues to play an important role. However, considering that the major tech stocks have not only recovered but have gone on to form new all-time highs on multiple occasions this year, many are questioning whether we have a tech bubble.
This is a valid question, but I would be asking this question about the entire equities complex. Many stocks have recovered most, if not all of their losses from earlier this year. Meanwhile, in the real world, the global economy remains in a fragile state and the recovery is slowing. Much of the market recovery can be attributed to the significant amounts of monetary stimulus injected by the Federal Reserve through quantitative easing, which causes asset-price inflation. There are more than enough reasons to suggest the current rally in tech or the broad equities complex is a bubble, but it is unlikely to burst anytime soon.
Central banks around the world have cut rates this year and yields in other asset classes are close to zero. This has pushed investors towards equities who know that over a long period of time, equities can provide strong returns. Furthermore, there is somewhat of an over-reliance on the Federal Reserve, with investors believing that if there was another stock market crash, the Fed would bail them out.
If we look more specifically at the technology sector, then they have struggled much less this year as many companies already had an infrastructure in place to continue operating from home. A lot of these companies also sell services like cloud computing as mentioned earlier and this part of a company’s business would not have taken a significant hit this year. This is not only because the service can be classed as a necessity, but also the fact that demand for these types of services will have increased this year as other companies set up a work-from-home infrastructure. Therefore, although there are certainly valid reasons to suggest this year’s rally in tech has been far too aggressive and is probably due for a correction, it is unlikely to happen in the near future.
What Next for Tech?
The tech sector is likely to continue leading the stock market in the coming years, but the pace of the moves will be impacted by the upcoming elections. Joe Biden is forecasted to win the elections this year, and if the Democrats are able to take control of Congress then we could get some headwinds for the tech sector in 2021. The Democrats have voiced their opinions about how major tech companies have far too much dominance in their sector and they could look to break up these companies. Whilst this could benefit smaller companies in the sector, the largest companies would end up taking a hit. Another risk is the possibility of corporate tax hikes or even a ‘tech’ tax in the coming years. Under a Biden government with a split Congress, these risks would be reduced.
In any case, with more stimulus expected from both the central bank and government, equities in general are expected to move higher over the next 12-24 months. The pace will probably slow quite considerably from what we have seen this year, but I would continue looking at buying the dips in both the tech sector and the wider markets.