US markets, at a broader level, have crossed dotcom-level valuations in some metrics. Is there value in buying now?
As equity market continues to hit new record, concerns regarding the valuations, specially of US equities, are being raised. This, coupled with supply chain issues, inflation, taper by US Fed and worries around Omicron, has made investor sentiments jittery. This year, till now, such concerns have been mitigated by robust corporate earnings, which have handsomely beaten estimate.
While P/E ratio globally seems elevated, it appears to offer little insight. This is largely because the emergence of many large, higher-growth technology companies in the 21st century has distorted historical comparison. Further, it tends to ignore elements such as long-term growth prospects, cost of capital, and opportunity cost, from making any investment decision. Finally, earnings (and dividends) tend to be a much more important driver of returns. As long as earnings can outgrow the multiple contraction, then investor generally experience positive return.
Globally, investors have also paid premium to owning tech stocks, especially those that have been able to establish economic moat over the others. Stock prices of such stocks reflect revenue and earning far out in future. The innovation by tech companies in terms of constantly developing new line of products and services makes it very difficult to keep predicting the probable revenue for such stocks — and hence to fully factor such growth into valuations and earnings estimates. As a result of which consistent surprises into the earning of such stocks are visible.
As far as comparison with dotcom level is concerned, the current expensiveness of the market appears to be different. For instance, at the peak of dotcom, the 12M Forward P/E for Nasdaq-100 Index was trading at an average of 63.61x for entire 2001 and at level of 46.99x for the first half of 2002. This was largely because the denominator, i.e. earnings for most of the Nasdaq-100 companies were negative at the time as they were called “concept stocks” back then. Currently, as on November 30, 2021, the long-term average of 5 Yr for Nasdaq-100 stands 23.81x, with level being 1.34s away from mean. This means the market appears to be relatively expensive but not quite similar to the dotcom level. The underlying fundamental of the companies have improved significantly vis-à-vis level observed during dotcom.
Lastly with regards to investment opportunity in the tech space, we believe that the fundamental long-term growth prospect continues to remain intact for these tech companies but given the uncertainty associated with macro-economic data such as inflation, interest rate and Fed expectation, investor can consider for staggering investment rather than lump sumor invest during market corrections unless opportunity present otherwise.
Without the support of 5-6 stocks, Nasdaq Composite YTD performance would be in the red. So, where do you see opportunities within and beyond tech stocks?
Some of the heavy weight techs have done relatively well but, overall, the smaller ones have also caught up in the long run. One way of evaluation is to compare performance of Nasdaq-100 Index and Nasdaq-100 Equal weighted index. On 10 Yr. cumulative annualized basis NASDAQ-100 Index has generated return of 22.65% per annum whereas NASDAQ-100 Equal Weight Index during the same period has generated return of 19.35% per annum (Sep 30, 2021). While the equal weighted index has underperformed Nasdaq-100, overall return has been higher than S&P 500 Index which had generated return of 13.85% for 10 Yr. during the 10-year period.
This highlights that even non-dominating tech stocks have done reasonably well over the years, making a case for themselves in an investor’s portfolio. Tech stocks, specially the US domiciled, continue to appeal as they are the driving force behind some of the major innovations that are spear heading mega trends. Technology is one of the few sectors where the growth in underlying earnings have outpaced the growth in their price over the long run recently.
Thus, investors should continue to make allocation to tech stocks as part of their portfolio depending on their risk appetite. From a long-term perspective and beyond, tech stock investors can continue to look at broad-based, sector-agnostic indices such as S&P 500 Index or S&P 500 Top 50 Index, from allocation point of view.
Which companies/sectors do you see performing well in 2022?
While we expect generally more moderate equity equities returns for 2022, It is reasonable to assume that the Fed might kick off rate hikes but remain more tolerant of inflation than it has been in the past. The timing and pace of higher rates will depend on its interpretation of “broad and inclusive” employment mandate but will also depend whether supply chain issue eases to cool down the 4-decade high inflation and what effect the same has on the consumption sentiments. While the virus strains can potentially delay, but not derail, the restart thanks to effective vaccine campaigns. We can probably see a short-term macro and sectoral impact, but the big picture is unchanged. We are, however, dealing with a convergence of events that have no historical parallels: the unique restart, new virus strains and untested central bank frameworks. In such scenarios, remaining invested in the known names, whether companies or indices, can potentially help investors to relatively safeguard their interest. There are several variables in the market right now, which has potential to create volatility in the market and especially for certain sectors.
With rising interest rate, IT stocks may see some near-term volatility, which may also be fuelled by investor concerns around valuation. In case Omicron impact becomes wider, sectors like energy, consumer durable and material could potentially get more impacted. Hence, we believe, from asset allocation point of view, the investor should take sector-agnostic exposure and may also take exposure in US tech stocks from a long-term point of view. While there may be volatility in the short term, in the long term, growth drivers remain intact.
Also read : Gold 2022 outlook by Chirag Mehta of Quantum MF
Some of the sharing-economy stocks listed in the US are trading at much cheaper levels than their new-age peers in India. Are investors better off buying them?
Investors are constantly battling the dilemma of paying premium to stock or sector vis-à-vis buying something which is available at discount. But at the heart of the price which an investor pays lies the growth prospects of underlying business. If the future growth prospects are dim, even buying something which is available at significant discount would not make sense for an investor, whereas for businesses or stocks which are able to establish its economic moat, investors would be fine with the premium they have paid for owning such stocks or sectors.
While the underlying business model of a US company may be similar to that of Indian tech stocks, the fundamental tech, product, market, reach and growth potential may be very different. At this point in time, investors would probably be better off taking exposure to the sharing economy stocks via funds that have made certain allocations to these companies — rather than jumping directly on the participation wagon of such stocks — as the true potential of such stocks is yet to be realised. .
Latest November data reveals that US inflation is at nearly four-decade high. How should investors play the risks that may emanate from this?
The unemployment rate is steadily falling back to its pre covid level of 3.5%, but the Fed will also be paying close attention to the labor participation rate (the share of the working-age population either with or actively looking for work). This fell sharply at the start of the pandemic. The labor participation rate is still well below pre-Covid levels. As of now it appears that one can expect inflation to be persistent and settle above pre-covid levels. The inflation jump that we are witnessing is being driven by the unusual restart dynamics of extraordinary demand bumping up against supply bottlenecks. We might see supply-demand imbalances to get slowly resolve by end of 2022, which might help some cooling in the inflation.
There was sizeable change in the monetary policy outlook this December 15, 2021, when Fed announced that are doubling the pace of tapering asset purchases, which set is to be completed by March 2022 as opposed to June 2022. Further, a majority of Fed officials now expect three quarter-point hikes in 2022 instead of two, dampening investor’s appetite for growth stock such as technology as high growth tech companies tend to have greater proportion of their earning and income coming from far future than near period, which when discounted on low-interest rate adds to the soaring prices of such stocks. While the expected news has already been factored by the market, it is the unexpected ones (like Omicron, etc.) that have which has increased uncertainty in recent times. In such a scenario of uncertainties, investors can potentially evaluate staggering their investment at regular intervals, which allows them to spread over the risk, or buy tactically when market corrects.