The Tech stock train leaves the station, or so it seems
We missed much of the blistering tech stock rally seen in the first seven months of 2023. This is unsurprising as most clients want moderate growth without the terrifying volatility that technology and similar growth stocks generate. Coming off a tech stock bear market, I largely subscribed to the thoughts of economists who, like Larry Summers, predicted that the Federal Reserve would likely “break things” in its belated effort to control soaring inflation. As if to confirm the Bear case, in March of this year, Silicon Valley Bank, affiliated with technology startups and influential investors, proved unable to honor depositor withdrawal requests. Ominously, the Federal government felt the necessity to step in to make depositors whole, a bailout. Other mid-sized banks teetered and were then merged or forced to sell off some of their business. It appeared that a banking crisis, even if smaller than that of 2007-2009, would slam the stock market and deflate all stocks back to 2022 lows and perhaps lower. There continue to be indications that more banks may teeter in the face of rising delinquencies, especially by office property borrowers.
Coming into 2023, Trusted Financial clients did own positions in two leading technology giants, Apple and Microsoft although allocation to technology related companies had been trimmed significantly due to 2022 tech stock price collapses, triggered by rapidly rising interest rates[1].
Confounding most analysts, including myself, technology stocks, which weigh heavily in the performance of major indexes like the S&P 500, bounced back after the banking scare, and resumed their rally in April. I continued to view the situation as fragile, so did not pile into tech stocks at that time. So far this year, most client portfolios generally performed in line with the publicly reported performance of “balanced” portfolio managers, rising modestly.
Nearly all clients, many whom I’ve served for some thirty to forty years, have endorsed my oft-stated mantra that “job number one is protecting your assets.” Most clients came to me after an unfortunate experience in the markets wherein the unexpected collapse of an investment made a serious dent in their finances. Their solution was to have their investing done by a professional who would provide experience and watchfulness to the investment process. For most, the goal is to maintain the buying power of their assets in the face of relentless inflation. For most, this objective has been satisfied over the decades. Trusted Financial clients are not demanding the services of a whiz kid who promises to beat the Market.
Since the beginning of the current quarter there has been a broadening of the rally. But worries remain: in fact, on August 15, the S&P 500 index closed below its 50-day moving average for the first time since April, as most tech shares saw profit taking.[2] There seems to be a slowdown in earnings, although they remain positive. Still, resumption of student loan payments and exhaustion of Covid support payouts is worrying some analysts. Further, it appears another game of “Chicken” is brewing with regards to the Federal budget ceiling. House Speaker Kevin McCarthy is struggling to honor his earlier agreement with Democrats regarding the budget in the face of emboldened deficit hawks in the Republican party[3]. A recent downgrade in the credit rating for US government bonds and bills is predicated on the uncertainty around whether interest and principal will be paid during repeated budget standoffs. As stated in past communications, with money market funds offering the best yields in over fifteen years, a large allocation to these, while not intended as a long term position, seems to be the rational approach.
Still, a couple of clients have expressed frustration at seeing a high percentage of their portfolio dedicated to holding money market funds[4], feeling they missed out on the recent technology rally. This is a natural human reaction. The emotional power of “FOMO” (fear of missing out) can overwhelm the thinking of even the most intelligent and capable minds. The value I add is to avoid an emotional response to market rallies as well as to market swoons. This could be interpreted as a formula for mediocrity. Yet it is an appealing approach for most clients, who have been burnt by past investing decisions that were driven in part by emotion. As a Trusted Financial client, you are always free to move funds to a self- managed account and use your own judgment as to what to buy and what to avoid. For some, it is important to be able to challenge their agile minds, to play, and frankly, to gamble. It is my hope that these folks will leave the bulk of their assets in my care, providing a foundation of long-term growth without extreme volatility. This is what I’ve delivered over the decades.
Despite my current belief that earning a safe money market return near 5% is attractive in these uncertain times, I have shifted some money to a few attractive buying opportunities in equities. Here are examples, not all of which were appropriate for all clients:
AGCO (AGCO)
Based in Georgia but with distribution throughout the globe, this company markets farm equipment: combines, tractors and sprayers and is a leader in “precision Agriculture”. Precision Agriculture uses technology to reduce input costs such as fertilizer and water to improve crop yields and save farmers time in managing their properties. Precision agriculture is a data-driven approach to farm management that can improve productivity and yields, thereby increasing the overall profitability of farming. Satellite communications, drones and software provide a leading edge approach that allows farmers to feed a growing world population with lower costs per acre and higher crop yields.
The company is growing, has high levels of profitability and manageable debt levels. One can argue that AGCO is, in effect, an investment in technology, or at least a tech derivative.
ASML (ASML)
This tech company supports a host of integrated circuit manufacturers. Its position is arguably the leading maker of semiconductor manufacturing equipment. It has seen a powerful rise in share price, but still appears to be relatively cheap compared to the “Magnificent Seven” technology companies that have gained the most attention this year. Company financials appear rock solid, and the company has a multi-year back log of orders.
ASML Corporation is the sole provider of EUV lithography machines which use extreme ultraviolet light to create the world’s most powerful semiconductor chips. This is a valuable position to hold and has earned them a monopoly for customers who wish to make the densest, most powerful semiconductors. ASML counts among its clients virtually all the top semiconductor manufacturers, including Nvidia and Taiwan Semiconductor Manufacturing. The only “negative”, is that ASML’s ability is seen as so strategic that they are no longer allowed to sell equipment to Chinese chip manufacturers.[5] Still, the company is straining to fill a backlog of orders, so this does not appear likely to pinch profits in the intermediate term.
Parnassus Fund (PRBLX)
This fund garnered the coveted 5 star ranking from the Morningstar service. They own a widely dispersed set of public companies, including technology companies. To quote Morningstar’s analyst:
“Shares have outperformed the S&P 500 in almost every market correction, including the 2007-09 global financial crisis, 2018’s end-of-year pullback, and early 2020’s pandemic-driven selloff. Its emphasis on companies with stable competitive footing helps drive its resilience… Its trailing five-, 10-, 15-, and 20-year risk-adjusted results through June 2023 all ranked in the category’s top 5% or better, with it landing top of class.”
The same lead manager of the fund has been in place since 2002, meaning that the fund’s success can be attributed to this individual who remains at the helm. The broader management team has also been largely in place for over a decade.
Parnassus has been a strong choice, especially for smaller accounts as it provides diversification that might not otherwise be available,
VanEck Semiconductor Exchange Traded Fund (SMH)
Semiconductors, or “chips” are finding their way into every conceivable piece of electronic equipment. Those who manufacture chips packed densely with transistors are expected to grab market share as Artificial Intelligence (AI) is deployed throughout the Technosphere. This fund is a low cost way to hold a sector that is in my opinion destined to show superior growth for the foreseeable future. The timing of this buy may be imperfect, as this sector has seen a large upside move in recent months, but it appears there is momentum that will soon resume. It is difficult for a non-tech person to properly know the details and relative strengths of competing chip companies, so the small, 3% allocation to a fund that owns a diversified holding of many companies appears to be the appropriate way to proceed. After comparing this ETF to others with a similar approach I settled on the Van Eck fund as having superior management and competitive internal fees.
Zoetis (ZTS)
This highly profitable spin off from Pfizer dominates pharmaceuticals for animals. I like the non-human healthcare market because there is no government insurance and thus no intermediary with negotiating power between the final consumer and the company. During the Covid 19 lock down, pet adoptions increased and along with that, demand for animal pharmaceuticals. However, this spike was short-lived. Still the secular trajectory is supportive: companion animals are treated like family members, especially by a rising cohort of aging Baby Boomers and empty-nesters. Just ask our cat “Buddy”:
Farm animal demand is flat to soft, and represents about 35% of revenue, so there are some headwinds. However, as with many of your holdings, my decision to re-enter this stock (we owned it, profitably from 2019 to 2021) was timed in tune with technical price action. The stock reached its highest level since mid-2022 in April, fell to test the two hundred day moving average, which held, then rallied above the April high. This, to me, was convincing action that suggests a new up trend is in place.
Cisco Systems (CSCO)
The leading networking equipment/software company. We live in an era in which the use of digital equipment represents the physical structure that supports a world that is rapidly relying on encoded information. The situation is analogous to the Industrial Revolution of the 19th century. During that time, rail lines, telegraph lines, oil pipelines and associated monitoring equipment supported the modern world to which we’ve bccome accustomed. Cisco is a dominant provider of switches, modems and connectors and over a thirty – plus year period has been able to adapt to the never ending changes in the digital environment. Now it is expanding software as a service offering, a source of subscription type revenue, representing almost a third of its revenue.
According to the Morningstar service, which accords CSCO a “wide moat” distinction, “we expect it to retain its leadership as enterprises adopt hybrid and multi-cloud environments with new technologies like software-defined wide-area networking, or SD-WAN. We also positively view its shift toward a greater mix of software and subscription sales”.
Cisco’s financial management is also attractive, as the company regularly raises dividends and has a policy of share repurchases that should dampen pressure from general market sell offs.
Cisco Systems faces competition from several companies in the networking and communications industry, such as Juniper Networks, Huawei Technologies, Arista Networks, and Nokia. These companies offer similar products and services in the networking space and often compete for market share and customers. However, Cisco dominates in installations in place. Once its hardware is embedded, it is difficult for customers to switch to a competitor.
Cisco also meets my criteria of a high return on assets and return on equity. Finally, recent price action appears to indicate a fresh wave of buying by investors.
I hope this little update is useful. As always, I’m happy to chat about the particulars of your situation.
Gary Miller, CFP
[1] According to FactSet, here is a sample of the losses in 2022: Apple, Inc, down 26.8%; Amazon, down 49.6%; Microsoft, down 28.7%; Nvidia, down 50.3%; Netflix, down 51.1%; PayPal, down 62.2%
[2] https://www.marketwatch.com/story/u-s-stocks-may-keep-falling-with-s-p-500-likely-to-snap-longest-streak-above-50-day-moving-average-in-3-years-1181a3ec?mod=mw_more_headlines
[3] https://www.latimes.com/world-nation/story/2023-08-16/mccarthy-stopgap-funding-government-shutdown
[4] https://finance.yahoo.com/news/elon-musk-says-treasury-bills-195144569.html
[5] https://www.reuters.com/technology/asml-shares-fall-report-us-wants-restrict-sales-china-2022-07-05/
