Big Tech stocks have been on a tear since April, largely escaping the fallout from Covid-19, despite a rocky year for the rest of the market. In fact, the pandemic has created huge tailwinds for tech giants such as Apple and Google by inciting behavioural shifts that will long outlive the health crisis. But economic recovery and regulatory headwinds could deflate the boom in Big Tech stocks, even as blockbuster earnings continue.
After the market collapsed in March, the FAMAG stocks – Facebook, Apple, Microsoft, Amazon and Google parent company Alphabet – bounced back rapidly. As of mid-December, they are on average up 44% on their value at the start of the year, signalling that investors remain confident they will be among the biggest winners of the post-pandemic economy.
The shift to a digital-first world created a surge in demand for Big Tech’s services, causing their stocks to rally, says Sean Markowicz, a research and analytics strategist at investment manager Schroders.
“As more people continue to be locked down, this has resulted in increased demand [for digital services] and this has created a virtuous cycle for their revenues and that resulted in superior stock market performance,” he says. “They've always done very well in the market, they've always been outperforming the broader S&P. What's different this time is the magnitude of divergence.”
By September, Big Tech had contributed almost the entirety of the gains made by the S&P 500 stock market index, which tracks the performance of the 500 largest companies listed in the US, during the year. Despite softening slightly on the back of the vaccine announcements, FAMAG stocks still represent half of the index’s annual gains as we approach the end of the year.
These stocks were also bolstered by a bounceback in the digital advertising market after an initial dip, adds Nir Kshetri, professor at the Bryan School of Business and Economics at The University of North Carolina-Greensboro (UNCG).
“While total ad spending worldwide is predicted to decline by 4.9% this year, digital ad spending will increase 2.4% [and] online display and online video categories are experiencing even faster growth rates,” he says. “All these led to better performance of Big Techs such as Alphabet [and] Facebook.”
A by-product of the outsized bounceback of FAMAG stocks has been increased market concentration. At the peak in August, Big Tech accounted for over a quarter of the S&P 500.
This has led to questions about the stability of the market, with some commentators drawing comparison with the dot com bubble of the early 2000s. But surging stock prices does not signal a bubble if the high valuations are justified, argues Markowicz.
Indeed, earnings for the FAMAGs has largely kept pace with the soaring stock market valuations. In the past four years, the earnings of the five tech titans as a proportion of total S&P 500 earnings has increased 42% and is projected to be more than a fifth by 2023, according to Schroders. And, with many companies struggling to deliver returns in the face of the pandemic, it is unsurprising that investors have flocked to FAMAG stocks that have consistently performed.
It is their commitment to innovation that makes Big Tech companies so valuable to investors, says Markowicz. “Their research and development... is the main driving feature of what makes them so attractive to investors,” he says. “They trade in the software and engineering and innovation that investors are willing to pay a premium for.”
Big Tech valuations after the pandemic
This rosy outlook is likely to outlive the pandemic, as Big Tech companies leverage the behavioural shifts from Covid-19 to expand their businesses and double down on investment in emerging tech, says Kshetri.
“While demand for some of the products such as videoconferencing services may adjust in the post-pandemic era, Big Techs are likely to perform well since these companies are rapidly embracing the fourth-revolution technologies such as 5G, AR/VR and artificial intelligence to launch innovative offerings for businesses and consumers,” he says.
But, even in the face of a continued earnings bonanza, Markowicz predicts that the performance of FAMAG and other “stay at home” stocks will weaken when restrictions loosen as other companies start to look more attractive to investors.
“Why would you be willing to pay 20 to 30 times a company's earnings if you can get something much cheaper, that's growing relatively quickly elsewhere,” he says. “Equities are likely to grind higher, just because of stronger economic growth, but we'll probably see underlying shifts in which sectors are likely to do the best.”
In the longer term, Markowicz also points to a maturing tech market that may make it harder for Big Tech companies to consistently deliver outsized returns. Over the past half a century, no single sector has retained its dominance of the US stock market and so it is “naïve” of bullish investors to think that it will be any different for Big Tech, even if these companies do remain industry leaders, he says, pointing to IBM as an example of a previous market leader.
“What drives the valuations of these companies is the wheel of innovation. If one of them starts to become less innovative than the market will immediately reprice those firms downwards,” he says. “As long as these companies [can] continue to come up with new products or they just buy up the competition, they have a good chance of sustaining these valuations.”
A potential obstacle to Big Tech’s growth prospects is increasing regulatory scrutiny on both sides of the Atlantic, which threatens to curb their ability to grow via acquisitions, monetise the wealth of data they hold, and capture new markets.
“If more people from the [US] Democratic Party are keen to rein in the power of these firms that could have implications for their valuations,” says Markowicz. “It does not [even have to] result in a change in their growth prospects - investors can get nervous. We saw that in 2017 after the Cambridge Analytica scandal.”
But while Big Tech will likely struggle to replicate historical levels of growth as we move into a new era of oversight and scrutiny, there are benefits to these companies from greater regulation, says Max Beverton-Palmer, head of internet policy at the Tony Blair Institute.
“There is potential for good well-balanced regulation around things like privacy and safety to align with the growth potential of these companies,” he says. “When we talk about regulation it is often seen as a net negative for companies… but actually making their services safer and better for the users can enable them to better use the data that they have."
