A year ago, when reports first emerged of a coronavirus outbreak in Asia, few could have predicted the duration and level of economic and societal disruption it would wreak.
Despite all that has occurred, we believe the technology mega-themes that are guiding the global economy toward a digital future not only remain intact but have even accelerated in some cases.
Pre-eminence of the cloud
Just as clouds can bring needed moisture that enables ecosystems to thrive, the digital cloud allows other transformational forms of technology to flourish. The efficiency gains in terms of scalability and analytical capabilities brought by the transition to cloud computing are unleashing the power of artificial intelligence, the Internet of Things and, more recently, 5G connectivity.
While each of these secular themes will play out over years, the cloud was put to the test last year. As societies locked down, companies scrambled to maintain customer engagement and back-office operations.
In this initial "reactive" stage, companies undertook a real-time war game of determining how the cloud could help them maintain business continuity in a remote work environment. Those that were lacking raced to adopt cloud-based applications, while many others with little-to-no digital footprints failed.
Companies have now entered what might be considered a more "proactive" stage of pandemic-driven digital adoption. With expectations of a hybrid structure of remote work growing and an even greater number of commercial transactions occurring online, management teams are now tasked with adjusting their business models to thrive in this new environment.
Such changes in processes can take several years to carry out, meaning the recent bump in demand for remote-enabling cloud services is far from ephemeral. The durability of the cloud as an investment theme is made evident by the fact that even with last year’s material increase in usage, cloud penetration remains at less than a quarter of its market opportunity.
Peering into 2021 – and beyond
We believe that the most consistent way to generate excess returns within technology investment is to identify the best companies with cutting-edge technology that will help redefine commerce and social interaction over a three- to five-year horizon. While the future remains bright for our favoured secular themes, this year stands to be promising for cyclical growers as well. Technology companies that are more exposed to economic cyclicality should benefit from a reopening of the global economy.
More importantly, despite following economic patterns, companies such as chip makers and payment processors are also beneficiaries of this digital sea change as we expect their cyclical lows to be incrementally higher as their products proliferate through the global economy.
This year should be favourable for companies that stand to benefit from a return to normality. Online dating platforms, for example, were surprisingly in demand during lockdowns and their prospects are expected to improve as people, once again, become more comfortable with in-person dating.
While the cloud came to the fore during lockdowns, we believe the pandemic has spurred management teams to identify ways to integrate AI into front- and back-office functions to improve business resilience. Less directly affected by the pandemic are other mega-themes. The ability of IoT devices to collect data, which can then be stored and analysed by an AI-enabled cloud, steadily grows. This should be complemented by the installation of 5G networks. While this is a gradual process and many consumer applications are yet to be determined, its promise of automating and optimising manufacturing is on a faster track.
Trusting one’s compass
For much of the past year, equity markets were dominated by secular growth stocks. More recently, as optimism surrounding Covid-19 vaccines has risen, so too have the prospects of cyclical technology stocks. The tension between these two categories still exists. The valuations in certain secularly driven technology sub-sectors have become extended. On the other hand, the promise of an economic reopening is being priced into cyclical growers. Risks are present for both. Should the economy successfully reopen and interest rate expectations creep up, valuations of long-duration growth stocks could be negatively affected.
Conversely, if weakening data were to continue throughout 2021, recent gains in cyclical growers could be reversed.
While these risks are not our base case, they should be on the radar of investors. The best way to navigate them is to set one’s compass toward what is the true north of technology’s future as defined by the secular themes of the cloud, AI, IoT and 5G connectivity.
However, there is a place within a technology allocation for cyclical growers and the key to consistent returns is striking the right balance between the two categories. But a focus on the most promising secular growth themes and those companies with the most durable competitive advantages requires only modest adjustments in one’s portfolio to compensate for economic developments and shifting valuations.
An allocation concentrated on cyclical forward themes, on the other hand, would require more pronounced repositioning as the economic cycle and market premiums ebb and flow.
Denny Fisher is a portfolio manager at Janus Henderson Investors, which is a member of The Gulf Bond and Sukuk Association.
