3 Reasons Why I am Not Worried About the Recent Tech Stock Bloodbath (and What I Plan to Do!)

What an excruciating couple of weeks it has been for tech investors like myself. Ever since tech stocks generally hitting a peak in February (as shown here in the tech heavy NASDAQ index chart), things have basically gone all the way downhill.

As of this writing, the index have shed 9.22% from YTD highs.

As you can imagine, my portfolio (that has a significantly higher beta vs the index) definitely took quite a beating of late. I can assure you, it is absolutely no fun watching helplessly as my portfolio shrinks and it can be pretty taxing emotionally!

However, digesting the turmoil and taking a hard look at my portfolio without the initial emotions, I actually walked away pretty happy and excited!

Over the next few sections, I will share some reasons why and also what I would be planning to do from here going forward.

1 – Mixed Market Signals Driving Uncertainty and Volatility

A sharp stock market recovery from bear territory followed by tremendous run in 2020 where all 3 of the major US stock indices ended on the positive (and breaking record highs along the way) happening all within a year blighted by a global pandemic driven economic recession is unusual to say the least.

It is worthwhile to take stock and understand what the key driver behind this market phenomenon is. As I have written in a previous article on the 2020 tech stock boom, a key contributor to the rapid rebound of the market is attributed to the massive quantitative easing (QE) and fiscal stimulus efforts by governments of developed economies around the world. In short, money is cheap and plentiful.

It would be reasonable to expect then that stock market performance in the near term will hinge a lot on government posture on their policies that is in turn tied to economic performance. Taking that into consideration, here are some of the select recent news (that some see as indicators of what’s coming next in this regard):

• Spike in long-term US Bond Yields (BusinessInsider)
• Bullish US economic forecast for 2021 (CNBC)
• Latest US jobless unemployment indicators still look grim (apnews)
• US to continued injection of stimulus into the economy (CNBC)

Trying to put together a coherent picture from the above news headlines is a tall-order since they seem to pull in different directions.

A positive sloping bond yield curve traditionally indicates that the economy is headed back into inflationary territory (and hence potential interest rate hikes), but yet it does not look like the government is ready to take their foot off the gas from a stimulus injection standpoint. A forecasted growing GDP would mean some businesses and industries that were hit hard by the pandemic are possibly going to have a turnaround and there are likely bargains to be found in the market but yet, there is still grim news coming from the economic indicator front and continued government stimulus seems to indicate that any turnaround isn’t coming anytime soon.

I believe what we are witnessing here is volatility that is driven by capital cycling around. Depending on one’s belief on where things are headed, commensurate actions follow. For example, if one believes a decent yield from a “safer” assets like bonds why would one risk having capital parked in tech stocks with frothy valuations? It is therefore, not surprising that many of the high-flying tech / growth stocks are taking the brunt of the hit. 

So what do I make of all this from my investment perspective?

Nothing much really.

In practicality, nothing here changes any of the thesis I have for the companies that I have invested in. Short term economic indicators do not affect tech driven megatrends like the adoption of cloud computing, shifts to clean energy, e-commerce and etc. 

One of the only risk I see is probably from a valuation perspective but bearing in mind that my investment conviction is generally around great performing companies being able to grow into its valuation over time, I therefore have no problems riding this volatility out (and hopefully up!)

2 – Healthy Signs of Tech Progression and Megatrends

There are several big reasons for why there is a lot of attention paid to the earnings of the tech titans. One of which is that the earnings from these companies serve as leading indicators for what is to be expected from various other companies in the tech space (and arguably beyond).

If we take a look back at some of the tech titans that have reported their results in late January and early February 2021, there are things to be gleaned and lend confidence to tech investors. For example, here are some noteworthy headlines from Microsoft Corp. (NASDAQ: MSFT) and Amazon.com Inc. (NASDAQ: AMZN) latest earnings:

• Microsoft’s Q2 2021 revenue was US$43.1b (+17% YoY) and EPS was US$2.03 (+34% YoY).  From their breakdown, revenue from Azure, Microsoft’s cloud offering grew 50% YoY(!) (source: Microsoft)
• Amazon’s Q4 2020 revenue was US$125.6b (+44% YoY) and EPS was US$14.09 (+117% YoY). From their breakdown, revenue AWS, their cloud offering grew 28% (source: Amazon)

Microsoft and Amazon are some of the largest companies in the world. For them to continue growth of their revenue at healthy double digits year-over-year is no mean feat and definitely noteworthy.

However in digging deeper, there is a lot more information that surfaces. Consider here the case of cloud computing. In one of my previous articles on why Cloud Computing is the future, we had a 2020 estimate that the segment of cloud computing that both Amazon and Microsoft participates in is worth approximately US$100b. We also had an estimate of market share for both companies – Amazon with 33% share and Microsoft with 18% share – that makes up for a little more than half the market. For these two companies to grow their cloud market at their latest reported rates considering their dominance and large base number is not only astounding but more importantly, it is a strong signal that the entire cloud computing market itself is very healthy and rapidly growing.

Consider then, who might be the customers of Microsoft and Amazon that is driving this growth?

I would wager that there is a fairly large piece of that customer base being large corporates or enterprises. The thing that is true with large corporates or enterprises is in their deliberate and committed choices in technology spend. In other words, once these folks commit to adopting a particular technology, more often than not, it is a multi-year commitment. This in turn, would have profound impacts on how work is done going into the future.

In short, one should not misunderstand that the growth of cloud computing is purely a pandemic driven phenomenon (though it is arguable that the pandemic has accelerated things somewhat) that will dissipate once things are over. On the contrary, signs are pointing towards a sustained and permanent shift that bodes well for the tech space at large.

Given this perspective, there is really no reason for distress, in spite of recent volatility. Nothing really changes for me here from an investment thesis standpoint in spite of recent volatility.

3 – A Season of really Hard Comparisons driving Volatility

As I have said before, 2020 has been a very unusual year. Amidst lockdowns enacted by countries around the world to combat the escalating pandemic, the tech space has suddenly been thrusted into center stage as it turned out to be the key in enabling many aspects of our lives to continue, in spite of physical inhibitions. 

Not only has tech afforded the opportunity for work to continue, it has also served as a key conduit for our desire for entertainment, interaction and inter-personal connection. It is clear that nearly everyone would have to adopt tech in one way or another in order to function with a remote sense of normalcy.

This new reality have certainly translated into some truly unprecedented financial results for many tech companies. When Zoom Video Communications Inc. (NASDAQ:ZM) reported their results in June last year for the quarter that was January to March 2020 (where we would’ve seen a month or so into the global pandemic play out), their revenue growth spiked to an astounding 169%. This was followed by several blockbuster (>300% growth!) quarterly results and eventually saw them close off the financial year recently at a full year revenue growth rate of 326% (!) over the previous year. In their latest guidance, the company is guiding for 42% revenue growth in the coming fiscal year.

If we can just take a moment to let the information above sink in, you will probably understand where the complications are. You see, for a company that has had their revenue’s quadruple over the past year, what will a reasonable growth expectation be when the effects of the pandemic is normalized? Is 300%+ growth last year vs. 40%+ growth this year a strong sign or should it be interpreted as an alarming growth deceleration? I can almost certainly tell you, no analyst in the world can give you a reasonable answer.

This conundrum that Zoom faces is a microcosm of the fate that many high-flying tech stocks will be facing in the near future. After a year of outperformance driven by truly unusual factors and circumstance, there is simply no precedence on how to properly compare results going forward from here and arrive at a reasonable expectation. Without a reasonable performance expectation, it would be even harder to arrive at any form of valuation. This is also the reason why, I believe continued volatility is to be expected, aside from the aforementioned macro environmental factors. 

From my perspective of investing, any given company’s financial results are but only one part of the investment thesis.

I do also consider a variety of other factors such as my understanding of the company’s business model, the strength of their business execution and competitive advantages alongside the potential market opportunity for the company. Volatility driven by current valuation difficulties in the tech space (which will normalize eventually) matter very little in my pursuit for investing in good companies that are playing in spaces boosted by clear megatrends.

A Summary and What I Plan to Do  

With this particular article, my aim is to share some of my observations and hopefully demonstrate how easily one can get caught up with “market noise” as well as risks associated with valuation, especially in the tech space.

Personally, I do not have a big problem with valuation risks as in my view, this can be mitigated by sizing my investment amounts appropriately and averaging up / down as we go along, so long as I have the conviction that the long term trend for the investment is headed in the right direction. Therefore, the key really is in developing the conviction level needed to continuously invest along, in spite of the volatility.

As of writing, many of the companies that I feel excited about and believe to have bright futures are trading significantly lower below their all-time-highs. While even with the recent declines, some of these are still pretty pricey, it is nevertheless significantly cheaper than what it was just a few weeks ago.

I am not sure about you, but I am looking to be in the mood for some shopping!

Disclosure: The author owns shares of Microsoft Corporation (NASDAQ:MSFT), Amazon.com Inc. (NASDAQ:AMZN), and Zoom Video Communications Inc. (NASDAQ:ZM). Investors should conduct their own due diligence before engaging in any buying / selling of any of the shares mentioned.