After the tumble: the top tips in technology
Last year was a dismal one for the tech sector’s equities, owing to dearer money and dwindling confidence following the SVB debacle. Philip Pilkington reviews the past few decades and assesses the outlook
The information technology (IT) sector has changed a great deal over the decades. When we think about the 1970s today, we think of old computer games like Pong, while today the sector is associated with smartphones. Yet these popular perceptions do not match the performances of IT stocks over the decades.
The best performer of the 1970s was Avnet, which clocked in a 190% return over the decade – pretty meagre by today’s standards. Many would find it hard to identify Avnet or what the company does today, but it is a distributor of electrical components with a storied history going back to the early 1920s. In the 1970s, Avnet partnered with the now better known Intel to supply computer peripherals and software.
The second-best performing tech stock of the decade was Hewlett-Packard (HP), a much more recognisable household name. HP produced a return of just over 167% over the decade. The company was supplying what were then called computers, but what today would be more recognisable as advanced calculators and advanced products for scientific research. HP was so focused on business and scientific products in the 1970s that when Apple co-founder Steve Wozniak offered them the results of his research on the Apple I personal computer, they turned him down five times, prompting him to start his own company with Steve Jobs.
A lot changed in the 1980s, both in terms of technology and stock returns. It is the 1980s that many of us associate with the emergence of the computer as we now know it; but this is not reflected in the market. The best returning tech stock of the 1980s was Badger Meter, with a whopping return of around 4,020% over the course of the decade. But Badger Meter was not a typical tech company in the sense that we think of one today. It was a pioneer in devices that measured water quality and flow.
Autodesk and Oracle dominated the 1980s
The second and third-best performers of the 1980s are more familiar to modern eyes: Autodesk and Oracle respectively. Both are, of course, leading software companies. Autodesk catered to industrial design companies, providing them with software to model products, architecture and engineering work. Oracle, as it does to this day, provided extensive database management. Oracle and Autodesk’s success in the 1980s paved the way for the integrated world of computation and tech that we see today.
In the 1990s, the industry matured, and the stock returns went gangbusters. Yet the names we see amongst the top performers of the decade are still somewhat surprising. In first place is Steel Connect, the supply-chain management company, with an eyewatering return of 87,633%.
These returns were almost completely reversed after the dotcom bubble burst, with the stock falling 99% – but not before the company bought the naming rights to the newly built stadium of the popular American football team the New England Patriots. Steel Connect’s decline is a reminder that during a technology bubble even those companies in a solid, unsexy business could get caught up in the madness. The runner up during the booming 1990s was Cisco Systems. Today Cisco is known as a sprawling conglomerate that does it all, from manufacturing networking hardware to developing software. Cisco’s success in the 1990s was closely associated with the rise of the internet and specifically the widespread adoption of the internet protocol (IP) communications system.
Cisco went on to become, in 2000, the most valuable company in the world before crashing back down to earth as the dotcom bubble popped. Once again, this highlights that it was not just fanciful businesses like the infamous Pets.com that rode the ups and downs of the bubble. Interestingly, we must reach far down the list to see many of today’s top performers. With a return of 9,370% Microsoft was only the seventh-best performing tech stock in the 1990s. Apple does not even appear in the top 25.
While the 2000s saw the emergence of many of the companies that shape our world today, the top performers, once again, surprise. Ansys tops the list with a return of nearly 1,500%. Ansys develops and markets complex engineering software. It has continued to go from strength to strength.
Today the shares are 15,000% up on their level at the beginning of the millennium. Recently, however, the company has found itself caught up in scandal, with the South China Morning Post reporting that the Chinese military used its software to design hypersonic missile technology.
There are some household names in the top ten of the 2000s, with Apple coming in at number nine and Blackberry (formerly Research in Motion) at number ten. Blackberry is another stock that teaches hard lessons to tech investors. In 2008, Blackberry’s stock peaked at around $145. But it soon crashed by over 95% and has never since recovered.
Yet Blackberry was no simple bubble. At the peak of its success, it dominated the business phone market. No serious businessman would have been caught dead in the mid-2000s without a Blackberry, with its full Qwerty keyboard and email access. But with the release of the iPhone 1 in 2007, Blackberry’s fate was sealed. When investing in tech it is not hard to get caught out by companies that are the toast of the town, until another one comes along and blows it out of the water with the latest innovation.
Today’s Big Tech: the Faang stocks
In early 2013 television pundit Jim Cramer had Bob Lang from TheStreet on his show Mad Money. Lang introduced the audience to a new acronym – Fang, comprising the top tech stocks, Facebook, Amazon, Netflix and Alphabet (then Google). Fang would later be expanded to Faang to include Apple.
The reason Lang highlighted these stocks and why markets continued to chatter about the Fangs for years afterwards is because they effectively ran the show. At the time of writing, the Fang stocks have lost much of their glow, but they still account for nearly 20% of the market capitalisation of the S&P 500. When markets
“Apple does not appear among the 25 bestperforming tech stocks of the 1990s”
were roaring in the 2010s, the Fangs led the pack. Between the start of the decade and their peaks in 2021, Amazon rallied by 1,995%, Alphabet 964%, Microsoft 1,043%, Meta (Facebook) 890%, and Netflix 6,900%. While these stocks have since fallen by between 17% and 45% from their peaks, they remain well above where they started the 2010s.
While these larger companies dominated the big indices, enthusiasm was generated for start-ups. Investors went in search of the holy grail: a small, relatively unknown start-up that would one day become a Fang. In the 2010s, venture capital poured over the markets like rain. In 2006, venture-capital investment in the US stood at about $30bn. By 2021, that number had peaked at over $345bn – an 11-fold increase. The buzz was all about tech.
Venture capital investment is a bit like running a casino. The profits come not so much from playing the wheel yourself and trying to pick winners, but rather by stacking the odds in your favour. Venture capital portfolios spread relatively small amounts of money over many investments. Many, if not most, of these investments will fail but the ones that succeed will result in profits for the investors because the return the successful company generates will be so much larger than the initial investment. A decade of data reveals that out of 4,000 venture capital investments, the top 100 generate between 70% and 100% of the overall profits.
This accounts for the frenetic activity and vibrancy that we have seen in Silicon Valley over the past 15 years. It also accounts for why, if you ever get an upand-close look at the industry, you see many bad ideas and more than a few “fake it till you make it” types amongst the would-be entrepreneurs. Both make for great headlines and so the financial press is chock full of both winners and losers.
While the bulk of the returns on Wall Street were generated by Big Tech, the market buzz of the 2010s and early-2020s was driven by Silicon Valley. The two trends were symbiotic. The innovation sector fed the narrative of the tech boom and occasionally contributed a new Big Tech player to the stockmarket, while the Big Tech players provided sufficient size to push the stockmarket ever higher. That is, until recently.
“Venturecapital investment is like running a casino: it helps to stack the odds in your favour”
Decline and fall
In the autumn of 2021, the Nasdaq index peaked at 15,971. It had been quite a ride. From the start of the present cycle in 2009, the index had rallied by 980% – annual returns of nearly 22%. But in the autumn of 2021, the Nasdaq started its decline. Today the index stands around 26% lower than it did that autumn, meaning that annual returns since 2009 have fallen from around 22% to 16%. This is still a robust return, provided, of course, the index does not fall any further.
While it is hard to attribute a specific cause to market declines of this kind, it is notable that in the autumn of 2021 inflation had started to pick up. When the Nasdaq peaked in November it had reached 6.8% in the US, far higher than the 1.2% seen the same month the year before. Throughout the year, both investors and central banks had been engaged in inflation denialism, telling
themselves that the price rises were just transitory and would soon settle down. By late 2021, the transitory narrative was no longer credible and so investors prepared for central bank rate hikes to try to control the inflation. Dearer money lowers the present value of future earnings, so down went the Nasdaq.
But this was only the beginning of tech’s troubles. The repricing of the Nasdaq and Big Tech was a case of markets looking at the new environment and revaluing the stocks. These repricings, however, did not consider that the tech industry itself might come under pressure. Yet the events of the past few weeks have shown that this is a real possibility.
In March 2023, rumours began to swirl about the viability of Silicon Valley Bank (SVB). SVB was a bank set up specifically for start-ups in 1983 and it had a good track record. The eventual collapse of SVB was unusual in many respects because, contrary to some media reports, the bank did not engage in any unusually risky practices.
SVB’s portfolio was mainly invested in long-term government debt and mortgage-backed securities, both of which are considered to be safe assets. But as interest rates rose precipitously, the value of these investments fell.
SVB carried very large deposits on its balance sheet because most of their clients were start-ups who received large injections of initial investment capital that they would live off for their first few years as a business. When these depositors realised that they were not covered by deposit insurance because their balances were too large, they got spooked, pulled out their deposits and SVB collapsed.
Then something happened that may taint the tech sector for a long time: the Federal Deposit Insurance Corporation (FDIC) stepped in and bailed out SVB’s depositors. FDIC insurance is only supposed to cover deposits of up to $250,000, but many of SVB’s depositors were much larger. The FDIC said that it was undertaking the bailout because of “systemic risk” but, as many pointed out, SVB was in no way systemically risky – and its depositors were certainly not.
Incompetent venture capitalists
The former chair of the FDIC, Sheila Bair, wrote an article in the Financial Times after the bailout, pointing out not just that the bailout was suspect from the point of view of the FDIC’s mandate, but that the SVB depositors “are a ‘who’s who’ of leading venture capitalists and their portfolio companies. Financially sophisticated, they apparently missed those prominent disclosures on the bank’s websites and teller windows that FDIC insurance is capped at $250,000.” Not only were the SVB depositors connected, but they also appeared to be incompetent at financial management.
It seems likely that the tech sector will lose its sheen from the FDIC debacle. Many of the prominent members of the Silicon Valley business community portrayed themselves as libertarian rebels; innovative, independent entrepreneurs who created from scratch while the big incumbent players relied on shady connections and dubious government contracts. No more. Now Silicon Valley was a major recipient of a government bailout.
Already under pressure from contracting stockmarket valuations, the tech sector has now lost a major part of the story that makes it attractive. It is no longer an industry of scrappy entrepreneurs standing up to The Man. Rather, it is a sector of financially illiterate bunglers who, when the chips are down, go cap in hand to Uncle Sam. In March of this year, twilight started to fall over Silicon Valley.
Salvaging winners
This is by no means the end of the tech sector. In the coming years, it seems likely that the weaker players will be shaken out and there will be less excess in the venture-capital sector. But many of the big players will remain. Put simply, Amazon and Alphabet are not going anywhere anytime soon. But because their valuations remain high, despite their decline since their peak in 2021, investing in these companies is now as much about timing as anything else.
The question potential investors should be asking themselves is whether the market carnage is over or whether it is just beginning. If you think it has ended, it might be worth dipping your toe into some of the Big Tech stocks. But if you believe it is just beginning, it is better to do your research now and hold cash to scoop up stocks on the cheap when the market declines.
The most robust targets are Amazon, Alphabet and Microsoft. Other Big Tech companies have potential problems with their business models. Meta (Facebook), for example, is not popular with younger generations and has limited scope for growth. Young people are not using Facebook but rather other platforms such as TikTok. Facebook has undertaken some clever acquisitions, like Instagram, but it has failed to innovate and so investors should be careful of getting saddled with an older incumbent player that is surrounded by competitors and unable to hold its own. Netflix has a similar problem – it does not have a solid monopoly position in the market for streaming video and so is seeing competition emerge from the likes of Amazon Prime, Disney+, YouTube TV, and others.
Amazon, Alphabet and Microsoft, on the other hand, have clear monopoly positions. Amazon dominates in online shopping and is unlikely to be challenged any time soon. Alphabet is number one in online search and competitors have made few inroads. Microsoft has a chokehold on subscriptions for business software and cloud computing. The business models of all three are robust and so investors should try to buy the stock of these companies when it looks cheap.
Microsoft’s stock is down by 25% from its peak, Alphabet’s 43% and Amazon 79%. While these may seem like huge declines, they are simply back at prepandemic levels. During the lockdown these stocks went gangbusters as people started to believe that life had changed forever and would be lived online.
As things got back to normal, shares sold off. None of these stocks are vastly overpriced and if you think that the pain for the tech sector is now in the past, all three are robust investments. If, however, you think there is more negative action on the horizon, hold on to your cash and get ready to pounce when the time is right.
“Amazon, Alphabet and Microsoft have clear monopoly positions”