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Silicon Valley is prone to bubbles. The biggest is the one it inhabits — 3,000 miles from the political and financial capitals of the US, snugly and smugly inventing the future. This is an advantage. As Benedict Evans of Andreessen Horowitz has pointed out, if you lived in a proper city you might never invent Uber.
Yet the outside world can intrude. This week the tech sector took an interest in Brexit. Entrepreneurs became instant experts in Article 50. Algorithms are being developed to work out how to simultaneously extricate the UK, block immigration and retain access to the common market.
Stocks were buffeted too and portfolio managers made changes. This may not turn into a global recession but after an unusually lengthy expansion in the US, thoughts are turning to what happens when the inevitable downturn does arrive. “We’ve been thinking about it a lot,” says Walter Price, who manages a $1.2bn technology fund at Allianz Global Investors.
The challenge is that a list of the biggest tech companies today looks quite different from December 2007 when the last US recession began.
The top three by market capitalisation now — Apple, Alphabet and Microsoft — are the same, though they have reversed their ranking. But the fourth biggest, Amazon, with a $330bn market cap, was a tenth of the size then and 13th on the list. The fifth and sixth biggest today, Facebook and Alibaba, were not even public. The losers over that period are led by Cisco, Intel, IBM and Hewlett-Packard. Broadly speaking, software and consumer-focused companies have been promoted; hardware and enterprise-focused companies have been relegated.
It means that different economic signals matter. Corporate IT spending used to be paramount, now advertising is crucial.
Google and Facebook might continue to profit from a secular shift to digital advertising from television and print media. But they are still reliant on a cyclical business.
At Apple, consumer confidence — and arguably luxury spending — is important. The company is very different from 2007 and as such its ability to ride out a recession is unproven. In 2007 the iPhone had just been launched. Now the device accounts for more than 60 per cent of revenues and is reaching saturation. It is hard to know how consumers will feel about spending almost $700 to replace their iPhones during a downturn, especially when the pace of innovation has slowed. But the betting has to be they won’t rush.
Amazon fared badly in both the last US recessions, losing 90 per cent of its value in the dotcom bubble and more than 50 per cent in the 2008 crisis. But these now look like blips. Since the start of the last recession, the stock is up 700 per cent. Amazon today is also a different company. Its cloud computing unit, Amazon Web Services, which offers data storage to companies, was only launched in 2006; it now makes more than 10 per cent of revenue and is growing quickly.
There is a lot of confidence that the migration to the cloud is a phenomenon that will only accelerate in a downturn. At the centre of the bet is Salesforce. It has made a loss in eight of the past 10 quarters but is many investors’ darling stock. “There should be more of a push into the cloud because it saves companies money, it’s more flexible,” says Mr Price.
You would think there would be a point at which the legacy vendors such as HP become so unloved that they are a worthwhile investment. Yet investors are prepared to let them sink. “The risk is that the legacy IT companies — instead of becoming value stocks become value traps and they slowly bleed out,” says Brad Slingerlend, a portfolio manager at Janus Capital Group.
Even if the market has divided the goats and sheep accurately and the winners’ businesses will hold up through a tougher economy, it does not mean that valuations will too. A wobble in February saw software companies, including Salesforce, fall 30 per cent.
The bulls are undeterred. “This ‘risk-off’ has hit the growth companies,” says Mr Price. “It’s like, ‘wow, this is a high multiple, I’ve got to sell it’, but it provides an opportunity.” Says Mr Slingerlend: “The stocks are much more volatile than the business models. We’re really prepared to take advantage.”
There are reasons to be cheerful across the board. Valuations are far below their dotcom bubble level. Many more companies than in 2007 are even paying substantial dividends.
Brent Thill, an analyst at UBS, points out that tech stocks have traditionally outperformed following a presidential election. This November, though, contains abnormal ingredients — a candidate that has threatened to use the White House to attack Amazon (“They’re going to have such problems.”) and promised protectionism. Donald Trump will be busy building walls; he might also finally burst the bubble.
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