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News and Views

The week to Tuesday’s close saw a sharp pullback in US equities as the tech giants that have dominated performance this year suffered sharp falls.  Technology shares gave up most of the extraordinary gain seen in August, falling by 9.1%, pushing the US stock market down 5.5%, and global stock markets down by 4.2%.  Closer to home, UK shares gained 1.0% and European shares gave up 0.8%.  Looking across other assets we saw weakness in commodities and modest strength in the UK fixed interest, both consistent with August’s generally weaker than expected PMI economic activity indicators.

The progress of the US technology stocks and of tech-enabled companies his year has been remarkable.  While much of that rally has been driven by revenue and profits growth as Covid-19 forced a new way of life on us all it was inevitable that they would follow the usual pattern, pushed ever higher by investor enthusiasm and momentum.

High volatility often marks a turning point – as indeed it did in March when markets bottomed.  So when we see it we need to consider what to do next. It is easy to over-intellectualise this process.  While it should dominate investment, valuation generally plays second fiddle to momentum and only becomes relevant at the extremes – when stocks have fallen far enough to provide a margin of safety to buyers or become so high that the probability of making a profit is just too small.  A more reliable strategy is to look at what other investors have typically done faced with similar situations because markets are made up of buyers and sellers and it is their interaction that causes prices to move rather than valuation. 

We’ve previously mentioned the importance of index-tracking funds – which do not take valuation into account at all – in driving markets. Large inflows into technology and growth stocks, index-tracking funds and even into actively managed funds have driven up demand and prices throughout 2020.  Aware of this and the strong momentum potential sellers have held off selling, simply riding the wave. Technology was rising not only on buying but also on a shortage of sellers.

However, many actually do need to sell. Perhaps they borrowed to invest, invested in derivatives or simply need the money. As long-term investors, we often assume others think the same way we do.  They don’t. All these loose holders are really waiting for is a trigger, something that suggests others have decided the time has arrived to sell. Most are not going to be thinking deeply about valuation or analysing balance sheets because they know that they don’t have to know what the actual trigger is.  They just have to recognise that it has been pulled and it is time to move. Before others do.

The return of volatility and this week’s fall in technology stocks might simply be a rational response to the excessive gains of August and be a short-term pull-back.  But nine months into the Covid-19 experience we are closer returning to normal.  And while that may well be more tech-enabled than before, any rational investor should be concerned that as life returns to normal so will our spending patterns. While it has been popular to speculate about how life has changed forever the reality will likely be more mundane and see us behaving as we used to and return to spend as we used to.  We are, after all, creatures of habit.  And habits are hard to change.  Technology does face competition.