Never mind the five American FAANGs (Facebook, Amazon, Apple, Netflix and Google) – wherever you look, technology stocks are soaring. Last week, Chinese giant Tencent surpassed Facebook's valuation, becoming the first Asian company to command a market capitalisation of more than $500 billion.
Eight of the world's most valuable companies are now technology stocks, three of them Asian – Tencent, Alibaba and Samsung.
Globally, tech stocks are up over 40 per cent this year, approximately double that of the MSCI World Index, which also hit all-time highs last week. While there’s been much nervous chatter about how the US bull market is apparently dependent on tech stocks, this is even more true of emerging markets.
The technology sector now accounts for almost 30 per cent of the MSCI Emerging Market Index, compared to 24 per cent for the S&P 500.
Although the Emerging Market index has almost 1,000 component stocks, just five – Tencent, Alibaba, Samsung, South African-based Naspers and Taiwan Semiconductor – account for 19 per cent of the index's value. There are two obvious takeaways. Firstly, diversifying across regions is no guarantee of sectoral diversification, with emerging markets even more reliant on technology stocks than the US.
Secondly, investors tempted by technology stocks but nervous about the FAANG’s hefty valuations might consider looking east: despite soaring share prices, Asian technology stocks continue to trade at an abnormally large discount to their US counterparts.
What’s in store for 2018?
Investors will hear much in the coming weeks regarding what’s in store for 2018, with all kinds of factors – valuations, economic data, earnings, market momentum – being cited by analysts and crystal-ball gazers.
With that in mind, investors would do well to remember some key details tweeted by market blogger Urban Carmel last week. Firstly, it's likely stocks will rise. Why? They usually do: since 1980, the S&P 500 has advanced in 79 per cent of years, registering median gains of 12 per cent. 2018 may be different, but don't assume it will: serious forecasters pay attention to base rates. Other widely-cited factors are less relevant. Economic data has been very good recently but this has "zero correlation" to returns over the next six months, says Carmel.
Valuations have “close to zero predictive value on next year’s return”, while what happened this year has “zero influence on next year’s return”. Carmel’s take: the base rate suggests stocks will advance. Some factors such as sentiment (too bullish) suggest below-average returns in 2018, although low recession odds indicate a bear market remains unlikely. Forecasts that are more refined than this, he cautions, are “pure speculation”.
Short-term outlook bullish
Predicting how stocks will behave in the remainder of 2017, on the other hand, is an easier task – traders will pounce on the most minor of dips and stocks will finish the year higher. That’s been the pattern throughout 2017, which is shaping up to be the first year since 1995 to escape a 3 per cent drawdown, and last week’s habitual rebound suggests it won’t change any time soon.
December has traditionally been the strongest month for stocks and money managers will be eyeing another Santa Claus rally. Almost all short-term studies point to further gains. Past instances where indices hit record highs in September, or enjoyed strong summer returns, or rose in traditionally difficult months such as August through October, or gained at least 15 per cent in the first 10 months of the year, or rose eight weeks in a row (all apply to 2017), were typically followed by above-average gains. This has been the "easiest market in history", noted Pension Partners' Charlie Bilello last week, and it's unlikely to suddenly get difficult in December.
Another fine earnings season
US earnings season is over and it's been another good one for corporate profits. When it comes to earnings, notes Schwab's Liz Ann Sonders, "better or worse matters more than good or bad", and companies continue to surpass expectations: 72 per cent beat earnings estimates.
They usually do, due to companies deliberately low-balling estimates, but the beat rate is well above its long-term average of 62 per cent. Companies are also delivering on revenues, which are more difficult to game: 67 per cent beat expectations, compared with their long-term average of 60 per cent. Unsurprisingly, tech stocks are leading the way. The sector’s 21 per cent growth rate is almost double that of the next best-performing sector, with a massive 90 per cent of tech stocks beating expectations. There are some clouds on the horizon, however. Firstly, the S&P 500 now trades on 18 times forward estimates, well above its five-year (15.7) and 10-year (14.1) averages. Secondly, FactSet data shows markets are “rewarding upside earnings surprises less than average and punishing downside earnings surprises more than average”. Expectations are rising and investors are getting fussier, indicating only the best will do in 2018.
