Several secular trends underpin our long-term enthusiasm for investing in the information technology sector, including the rise of digital payments, artificial intelligence (AI), cloud computing, and the Internet of Things (IOT).
However, the volatility of stocks in the sector, often driven by shorter-term factors, can leave generalist investors feeling burned by tech. Right now, a number of these factors are political. For example, policy priorities on President Trump’s agenda—including those pertaining to immigration, international trade, deregulation, and tax reform—may move certain tech stocks abruptly, depending on how, or if, those policies unfold. Specialist managers who’ve spent their careers investing in tech stand a better chance of navigating the price swings, especially when they have the ability and expertise to go short in addition to going long.
Potential for tech stock volatility may be driven by uncertainty of Trump policies
The dispersion of U.S. stock price returns has been muted in recent years, but we think this may be changing in light of the uncertainty surrounding Trump policies that could play a significant role in financial asset pricing generally and in tech in particular. We see the potential for a headline-driven market to result in a higher level of price volatility, which can be favorable for long/short tech investing: Intrasector dispersion, as measured by the standard deviation of stock price returns from 1990 to 2016, was widest within information technology.1
On balance, we view President Trump’s desire for tax cuts, reduced regulation, and increased infrastructure spending as supportive of tech stocks, but some will fare much better than others. We believe the details of certain policy items—and their potential implications for each tech company—merit close attention from tech investors.
Immigration reform may have unintended consequences for certain tech companies
As part of his buy American, hire American agenda, President Trump recently ordered a review of the manner in which H-1B visas are issued. U.S. tech companies hire extensively under the H-1B visa program to bring in skilled workers from overseas, and efforts to curtail the issuance of these visas could result in wage inflation and margin pressure at companies that make the greatest use of guest workers from abroad.
We’re watching to see how international trade talks progress
In March, President Trump released his trade policy agenda, which expressed the administration’s key priorities of negotiating better, and largely bilateral, trade deals; combating unfair trade practices; and eliminating barriers to foreign trade. While the president has previously accused China of engaging in unfair trade practices and currency manipulation, there are signs that both parties recognize the importance of maintaining a favorable bilateral relationship. Greater China—which includes Hong Kong and Taiwan—is not only a major source of demand for American goods, such as smartphones and PCs, but it’s also an important supplier of the electronic components needed to produce them.
Deregulation may free up corporate budgets for more capex on technology
As a key tenet of his pro-growth agenda, President Trump promised to cut regulations, eliminating two for each one enacted. A reduction in compliance spending would have broad implications for corporate profitability and could result in an increase in capital expenditures—capex—on technology, after years of pent-up demand. For example, the financial services industry stands to be one of the biggest beneficiaries of deregulation and accounts for nearly 20% of global IT spending.2 J.P. Morgan has stated publicly that the number of its employees responsible for regulatory compliance has doubled since 2011 and currently represents 18% of its workforce.3
Tax policy has the potential to increase tech stock buybacks and M&A activity
President Trump has outlined a plan to lower personal, corporate, and estate tax rates. A reduction in the corporate rate should result in increased discretionary spending on IT infrastructure equipment, software, and services. He’s also expressed support for a one-time repatriation tax of 10% on previously untaxed foreign earnings. The tech sector stands to benefit disproportionately from this proposal, as companies within it hold nearly $800 billion in cash overseas.4 We believe this cash, if returned, would likely be used for a combination of stock buybacks and merger-and-acquisition, or M&A, activity. Either way, we view the tax holiday as a big potential positive for the tech sector.
Whether it’s politically driven or not, disruption tends to create winners and losers in technology. The bigger the change, the greater the likelihood that new industry leaders will emerge while others will be left behind. With a dispersion profile that’s been among the highest of any sector in the market, technology can create a fertile environment for active managers able to implement long—and short—ideas into investors’ portfolios. We still believe that managers with extensive industry expertise, deep resources, and a global footprint will be in the best position to identify the companies that will—or won’t—change our daily lives.
1 Standard & Poor’s, Wellington Management, 2017.
2 International Data Corporation, April 2016.
3 J.P. Morgan, 2017.
4 Moody’s financial metrics, company filings, 2017.