It feels like investors have been on a wild ride over the past week as tech stocks plunged, dragging down major global indexes with them. A few factors contributed to the fall: The first was Senator Mitch McConnell’s comments that a U.S. fiscal stimulus deal may not come to fruition in the next few weeks. Then, concerns rose about the potential for a contested election in the U.S. presidential race if no clear winner is declared on election night. Add to that concerns about frothy valuations in the tech space — the result was a very substantial sell-off for tech stocks with reverberations in global markets.
Some are suggesting this is the start of another dramatic sell-off, similar to the spring of 2000 when the “tech bubble” burst. I highly doubt that. Yes, this sell-off was significant, and I wouldn’t be surprised to see it continue over the coming days. However, I warned just a few weeks ago that we should be prepared for the possibility of a sell-off after such a strong rally. I think of this rout not so much as a correction, but as a digestion given that the NASDAQ Composite rose more than 60% from its March bottom in the course of less than six months.1 All In all, I think this is a healthy period of consolidation after a dramatic run-up.
Below are three reasons why I believe that tech stocks are not experiencing another bursting bubble:
1. Today’s interest rate environment is much different
First of all, the interest rate environment is very different in 2020 than it was in 2000. Recall that in the summer of 1999, the Federal Reserve (Fed) began raising rates. By March 2000, the effective fed funds rate was 6.17%.2 After stocks began falling, the Fed kept raising rates. By June 2000, the effective funds rate was 6.86%.2
By contrast, the effective fed funds rate in August 2020 was 0.10%.2 And we just heard from Fed Chair Jay Powell in his Jackson Hole speech that the Fed is changing its inflation targeting policy to be even more accommodative. In other words, this is a very different monetary policy environment than what we saw in 2000 when the tech bubble burst.
2. Key themes may support long-term tech growth
The technology sector has been benefiting from several key themes that have emerged in the pandemic, and I believe many of those themes are likely to be enduring:
- “Be at Home” theme. Spending more time at home is perhaps the most obvious theme that has emerged in the pandemic. This includes those people who are working from home, being educated from home, and/or exercising from home. I think of it as a much larger version of the “nesting” theme experienced in the United States after 9/11, when many Americans were fearful of traveling due to terrorism and spent far more time at home. Today, many people around the world are spending money to renovate and retrofit their houses to their needs, and companies are spending more on technology to ensure employees can work efficiently from home. In my view, beneficiaries have included a variety of technology companies — especially software, storage, and security — as well as home improvement companies, online education companies, and digital health companies. All these themes should endure post-pandemic, in my view, although with varying degrees of popularity (online education being the least popular given the difficulties associated with at-home learning for children; I can vouch for this conclusion personally).
- E-commerce. Purchasing goods online is a long-term trend that accelerated dramatically during the pandemic for obvious reasons. The safety and ease of pressing a button at home and having goods delivered to one’s doorstep has proved indispensable during the pandemic. We expect the types of goods and services sold online to expand as the pandemic continues. Even when the pandemic has ended, e-commerce retailers are likely to retain a much higher share of overall retail sales than pre-pandemic.
- Artificial intelligence. Artificial intelligence is a powerful innovation, and in my view, demand for it has only accelerated in the pandemic. For example, imaging methods and tools that utilize artificial intelligence are becoming increasingly useful in the detection and treatment of COVID-19. More generally, artificial intelligence is helping many businesses become more efficient and work smarter in this difficult environment. Natural language processing (NLP) is a subset of artificial intelligence that is specifically concerned with the interactions between human linguistics and computers, such as speech recognition. Artificial intelligence has the potential to dramatically enhance productivity, and so I believe it may be a powerful trend that has staying power beyond the pandemic.
- Automation — drones and robots. The pandemic has underscored the need for robots and drones to perform essential tasks without the possibility of catching or spreading the virus. For example, the more robotics on an assembly line, the less vulnerable it is to closure because of COVID-19. Similarly, drones are being developed to deliver goods, which would also help to reduce the vulnerability of an essential service during a pandemic. Beyond the pandemic, automation is likely to accelerate even further because of the productivity enhancements and cost efficiencies it provides.
- Financial technology. Another trend that has received increased attention during the pandemic is cashless payments. The spread of COVID-19 has decreased the use of cash because of concerns that the physical exchange of money could spread the virus. A number of financial technology (fintech) companies have benefited from this trend, which is likely to continue post-pandemic. In my view, one notable fintech beneficiary of the pandemic should be blockchain, which has applications in many different industries and can help facilitate commerce without physical contact. For example, public land records can be digitally recorded via blockchain, reducing the need for physical record examinations as part of a title search. While this is particularly helpful in a pandemic, it may also be more efficient, which means it is likely to be a trend that has staying power. Interest has also been growing in tokenization and distributed ledger technology.
3. Progress is being made in the fight against COVID-19
No, I’m not one of the bright-eyed optimists who believes a vaccine will be available for distribution on Nov. 1 (my assumption is that an effective vaccine will be distributed by next summer). However, progress is certainly being made on therapies to reduce the severity of the novel coronavirus. The World Health Organization (WHO) made an important announcement last week based on evidence from several recently published clinical trials. The WHO recognized the efficacy of steroid drug use in reducing the severity of COVID-19, and it recommended that doctors use steroid drugs to combat the virus in severe cases.
In general, doctors and hospitals have learned much from fighting the virus thus far, and those learnings have already reduced mortality rates — just consider how much higher the mortality rate was in the Northeast U.S. this March and April versus the mortality rates in other parts of the U.S. in the late spring and summer. In my view, that should be positive not only for the economy, but for stocks in general.
In summary, there are important reasons to be positive on the tech sector, in my view. That doesn’t mean there won’t be more down days or higher volatility, but I believe in the longer-term prospects for the sector. And I believe the bias remains upward for risk assets in general because of extremely accommodative monetary policy by central banks around the world, but most especially the Fed.