Lots of questions! Big picture questions!! Good questions!!!
Diversification (not all eggs in one basket) is a way of managing risk. And also allowing exposure to assets that a more narrow portfolio may not hold, such as exposure to international (Aust is less than 2% of global market); there are many sectors barely represented in this country.
But then the issue of timing creeps in. Tech has done well; but has the run been made, and is it mean reverting? In other words, will the gains made by growth stocks get trimmed and value style return?
The great salutary lesson for tech was the 2000 bubble: “To be desirable an internet company must be ever so slightly unknowable.” “It must remain forever in a state of pure possibility.” – Michael Lewis (Liar’s Poker, The Big Short, Moneyball, The Blind Side, Flash Boys, The Fifth Risk), wrote in February 2000, a month before the tech stock bubble burst.
Since late March 2020, the S&P500 (which includes the large-cap tech stocks) has risen 46 per cent. The technology-laden NASDAQ has climbed 56 per cent. The “FAANG+” stocks – Facebook, Apple, Amazon, Netflix, Google and other big techs like Tesla – have soared 83 per cent.
And it is seen as an acceleration of a trend; according to Morningstar research, for the year-to-date large value stocks have underperformed large growth stocks by nearly 23 per cent. Over 12 months the performance gap is almost 25 per cent against a five-year average of 8.43 per cent and a 10-year average of 5.22 per cent.
“Most conventional stocks can be conventionally analysed by discounting their future cash flows by a risk-free rate, plus a risk-premium that reflects the investor’s assessment of the possibility that the cash flows won’t meet their expectations.
When the risk-free rates – generally the long term bond rates – are near zero, or even negative, and equity risk premiums are compressed by competition because investors are all chasing the same returns from the same investments, stock prices will rise. Investors will accept the lower returns for greater risks because they have no positively real-returning alternatives.
Tech stocks, because their upside isn’t and can’t be defined or capped, meet the Lewis description of being “slightly unknowable” and having “pure possibility.”
The pandemic, which has injected massive doses of new ultra-cheap liquidity and credit into financial systems and economies, is amplifying and accelerating the long term trends and causing investors to chase the stocks with the most amounts of “pure possibility.”
The moment those stocks, priced for something beyond perfection, become knowable – the moment any limit to that potential can be discerned and they can be assessed more conventionally – of course, their valuations will plummet. – Steven Bartholomuez
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