Be bullish on technology – but get the theme right

Lockdown has increased demand for technology, following an explosion in the number of people using the internet to work from home.

| 6 min read

This increasing use of technology is clear in the performance of Nasdaq, as its composite index down just 1% in 2020 so far, compared with a loss of 10% in the S&P 500 and a 23% fall in the FTSE 100. But, as the year progresses, the specific areas of technology that are the real winners from this crisis are likely to emerge. Not all technology companies are the same.

Because equity market performance is being driven by headlines over infection rates and central bank responses, there is currently a high degree of correlation between individual shares. When negative news on the spread of Covid-19 emerges – the market tends to fall. When the Federal Reserve announced it is going to pump even more trillions into the equity markets have been responding with a rise.

Divergence ahead

However, this broad-market correlation is likely to break down over the next few months. This will result in shares prices reacting to more fundamental issues that relate to each specific company. This means the importance of share selection is about to get more important for those seeking the best returns.

The rise of exchange-traded funds (ETFs) in recent years means that access to investments focusing on individual themes is easier to access than ever. So, as the wider market correlations break down in the next few months, technology investors need to get more thematic.

The biggest change from the reaction to Covid-19 is the rise of working from home. For many, this could go on for quite some time, as the timetable for lockdowns in most major economies is uncertain – and any loosening of social-distancing measures is likely to be phased. Once lockdown ends, many will decide that a balance of home and office work will be more suited to their lifestyle and productivity.

To suggest that this marks the end of the office as we know it is clearly absurd, as face-to-face discussions are better for communication and the social aspect of the work environment cannot be overstated. But people have adapted to this way of working – and the systems in place to make this happen. A balance of office and home work is certain to be a feature of any post-recovery world.

Two near-term themes

This means that two of the major themes within the wider technology space are likely to be at the vanguard of sector beneficiaries – namely cloud computing and cyber security. These two areas of spending are not discretionary in the current environment.

Cloud computing – essentially the centralisation of data on third-party servers that makes information available to many users over the internet – will clearly be a winner. This implies that big technology companies that offer these services – such as Amazon through its web services unit AWS or Microsoft via its Azure platform – are well placed to take advantage.

However, regulatory headwinds for Big Tech are growing – and the sheer size of these companies means they are likely to face antitrust issues should they wish to use M&A to consolidate their position. Some of the real beneficiaries of this trend are therefore more likely to be business software players, which can use the cloud to increase productivity at home. They are also in a better position to consolidate their position by acquisition, as they are likely to be under the radar of the world’s competition regulators.

Long-term view

Of course, the whole point of thematic investing is to position investors in a trend for long term returns, not just the current unusual market circumstances. Cloud computing meets these requirements too, as the advent of 5G mobile services will continue to drive opportunities in the sector. The ‘Internet of Things’ is likely to drive huge growth in the number of connected devices, with the cloud becoming the backbone of the rise of smart cars, smart homes, smart offices and smart factories.

Decentralised working also means that cyber security is a ‘must have’ rather than a discretionary spend. Governments and companies will continue spending on cyber security, even in a recession. Indeed, since the Covid-19 epidemic grabbed the headlines, there has been a significant leap in phishing emails from criminals trying to exploit the pandemic.

There are two other important themes within technology that also have solid long-term arguments supporting their outlook: Artificial intelligence (AI) and robotics. Drug companies are already using big data sets to develop new medicines and robotics companies have a substantial opportunity to develop the products demand by a post-pandemic world. For example, the cruise industry has been hit particularly hard by the spread of coronavirus. As the industry fights to recover confidence in its target market, sterilisation robots – which are already used in some hotels – could reassure concerned travellers that the ships have “hospital-level” sanitation standards.

However, the beneficiaries of AI and robotics trends are unlikely to see an immediate increase in demand. Finance directors at major business are slashing capital expenditure to try and keep their balance sheets strong, so these themes are likely to really take off next year rather than in 2020. As working from home has become a major theme in our lives, it is also a theme that is likely to drive stock market returns this year. It’s not good enough just to be invested in ‘technology’ you need to pick the right underlying trend.

A version of this article appeared in Monday’s Daily Telegraph.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

Be bullish on technology – but get the theme right

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