Market-Cap Equity’s High Tech Trouble

Insights

Market-Cap Equity’s High Tech Trouble

LILY SULLIVAN
Equity Strategist

DECEMBER 18, 2018

The Information Technology sector continues to drive returns for US equity markets despite the recent market correction, in which several of the major technology stocks, including Apple and Amazon, fell by more than 20%. The high flying technology stocks –Apple, Amazon, Microsoft, Netflix and Alphabet (Google)—have contributed nearly 50% to total S&P 500 returns year to date, as of November 30, 2018, and 15% since the Global Financial Crisis lows in March 2009.

CONTRIBUTION TO S&P 500 INDEX TOTAL RETURN, YEAR TO DATE

Source: Bloomberg, as of November 30, 2018.

As a result of the sustained positive trend in performance, consumer facing technology oriented names within the Communication Services and Information Technology sectors, currently make up 30% of the index based on their market cap weight and GICs classification, thus elevating concentration risk in US market-cap indices. Ample profit margins generated by these companies have pushed the S&P 500 Index 12-month trailing profit margin to a record 10.1% as of the third quarter of 2018, more than double since the 1990s. However, this reliance on Technology may make profits and future growth expectations within traditional market-cap equity indices more susceptible to an economic downturn.

TECHNOLOGY COMPANY PROFIT MARGINS HAVE BOLSTERED S&P 500 INDEX

Source: Bloomberg. Data through November 30, 2018. Trailing 12-month profit margin.

Additionally, technology stocks remain most vulnerable to increased global trade tensions and protectionist tariff measures, as the Information Technology sector derives over 50% of their revenue from outside of the United States.

S&P 500 SECTOR GEOGRAPHIC REVENUE EXPOSURE

Source: Factset. As of November 30, 2018.

The US stock market’s retreat during the fourth quarter has begun to spark further concern in investors that the high flying technology companies, will not be able to continue to boost sales at the same pace amidst fears of protectionism and rising interest rates. As we enter into 2019, and what appear to be the late stages of an extended economic cycle, we believe US and Global equities continue to be well positioned for future growth with a forward price to earnings ratio for global stocks reaching five-year lows as a result of the fourth quarter sell-off, dropping to 13.3x down from over 16.0x in early 2018. However, as volatility resurfaces, global growth slows down and trade tensions increase, the risks embedded within market-cap weighted equities may be amplified by a heightened concentration in growth stocks, particularly within the Information Technology and Communication Services sectors. Prudent investors may consider lightening exposure to market-cap equity index funds, rebalancing in favor of sustainable dividend, lower beta and value oriented holdings which seek to provide equity participation with less vulnerability to drawdowns amidst heightened volatility. Additionally, as increased risks are associated with every asset class, it is important to also maintain and/or add to alternative allocations such as Equity Market Neutral, maintaining exposure to an uncorrelated source of returns, distinct from traditional stocks and bonds.

IMPORTANT INFORMATION

The strategy outlined is not currently offered and as such, no clients are invested in this strategy. It is purely hypothetical and the performance returns and other statistics were calculated by QS Investors using published data sources, which have been noted throughout this paper. This material is intended for informational purposes only and it is not intended that it be relied on to make any investment decision. It was prepared without regard to the specific objectives, financial situation or needs of any particular person who may receive it. It does not constitute investment advice or a recommendation or an offer or solicitation and is not the basis for any contract to purchase or sell any security or other instrument, or QS Investors, LLC to enter into or arrange any type of transaction as a consequence of any information contained herein. QS Investors, LLC does not give any warranty as to the accuracy, reliability or completeness of information which is contained in this document. Except insofar as liability under any statute cannot be excluded, no member of QS Investors, LLC, the Issuer or any officer, employee or associate of them accepts any liability (whether arising in contract, in tort or negligence or otherwise) for any error or omission in this document or for any resulting loss or damage whether direct, indirect, consequential or otherwise suffered by the recipient of this document or any other person. The views expressed in this document constitute QS Investors’ judgment at the time of issue and are subject to change. Past performance or any prediction or forecast is not indicative of future results. Investments are subject to risks, including possible loss of principal amount invested.

QSCR 18330 (December 2018)