Technology companies have in recent years functioned as locomotives for equity markets, with significant share price rises - but are we heading for a bubble?
Digital giants Microsoft, Apple, Alphabet, Amazon and Facebook are not just the five largest companies in the US stock market, but also the five companies that contributed most to total equity return last year - exactly as they did, incidentally, in 2017.
Tech companies have been the undisputed principal driving force behind rising equity markets for quite a few years now, and anyone who remembers the collapse of the dot.com bubble 20 years ago will be constantly asking themselves if this can really continue.
We have asked Danske Bank's investment strategist, Lars Skovgaard Andersen, to assess the health and prospects of US tech companies, which are particularly concentrated in the IT and Communications sectors - though Amazon belongs in the Consumer Cyclicals sector.
Overall, we still see an attractive return potential in technology companies, where we do not see any particular signs of a bubble forming.
Lars Skovgaard Andersen
Investment strategist, Danske Bank
What is the key difference between companies then and now?
'Whereas equities were being traded at unrealistically high valuations 20 years ago, there is a basis for valuations now. In P/E terms - in other words, the price per unit of earnings in the companies - these equities are indeed more expensive than the equity market in general, but on the other hand they have higher rates of growth. Moreover, tech companies are generally some of the most solid companies around, with low or no debt and strong cash flows,' says Lars Skovgaard Andersen.
You had a particular focus on tech companies in the last US reporting season. Why - and what did the financial reports show?
'Now that tech companies have functioned as locomotives for quite a number of years, markets can be extra sensitive if these companies begin to lose momentum. However, we had a good US reporting season, particularly in traditional tech companies in the IT sector that supply infrastructure in the form of networks, semiconductors and software, etc. This confirmed the sector is still moving forward.
'Looking at more consumer-related digital companies, such as social media, streaming services and gaming, which are in the Communication Services sector, things here have also generally looked fairly robust despite a few missteps along the way.'
Strong growth in the IT sector
Whereas US equities have given an overall return of 76.5% in the past 5 years, that figure is 168.2% for equities in the IT sector. Historical return is not a reliable indicator of future return.
Source: Macrobond, total return in USD.
How do you rate growth in the tech sector going forward?
'I see a trend whereby companies perhaps cut back on investments in new machinery when they are uncertain about the future, but are less inclined to cut back on the digitalisation of their business and continue to invest in software and digital security, etc. Companies across all sectors constantly need new technology to remain competitive in a world that will simply become even more digitalised in the coming decades - therefore I still expect the area to experience solid growth.
However, this does not mean that all tech companies will enjoy growth, or that all themes within technology will thrive. As always, there will be both winners and losers, so investors may be wise to have a broad exposure to technology via one or more funds.'
This content is not investment advice - you should always speak to an advisor about how a possible investment matches your investment profile before making an investment.