Despite the US tech stocks dominating the market during the COVID-19 pandemic, the valuations are unlikely to be sustainable.
Ned Bell, chief investment officer at Bell Asset Management, said the speculative frenzy in the US tech sector was the dominant theme in August.
“While the FAANG stocks have been strong performers for several years, the recent performance has been quite staggering as speculators have pushed a handful of large tech names higher and higher,” Bell said.
“To some degree, we would suggest the current market frenzy is somewhat akin to the speculative investor behaviour of the late ‘90s that culminated in the dot-com boom and bust.
“While the IT giants are far more robust now, the current manic speculation does bare some resemblances to the late ‘90s when valuations were considered irrelevant, profitability wasn’t much of a consideration, thematics were king and momentum fed on itself.”
However, Bell said the recent performance of the big tech names was unsustainable and their valuations have become well and truly disconnected from their fundamentals.
Additionally, when looking beyond the FAANG stocks, he said the trajectory of the post COVID-19 economic recovery remained clouded.
“The economic pain inflicted by the pandemic has been extreme and doesn’t intuitively seem to be priced into equity markets at current levels,” Bell said.
“While we expect an eventual solid earnings recovery from global corporates, the current expectations implied by sell side consensus seems overly optimistic.
“While the market seemed to applaud the fact that most companies managed to beat materially lower earnings estimates – what seemed to be lost was the increasingly cautious outlook statements from many corporates.”
Bell also acknowledged the global small/mid cap sector had lagged behind the broader market.
According to FE Analytics, within the Australian core strategies universe, the global small/mid cap sector returned an average of 24.49%, compared to the MSCI World Index which returned 42.65%, over the last three years to 15 September, 2020.
“We would also point to the recent underperformance of the global small and mid-cap sector which has lagged the MSCI World Index by 4.74% annually over the last three years and 8.36% over the last 12 months,” Bell said.
“We fully expect this underperformance to mean revert quite sharply in the next 12 to 18 months.
“The eventual post-COVID earnings leverage in the [small mid/cap] sector will be meaningful, and as was the case post the dot-com boom and bust in the late ‘90s and post GFC [global financial crisis] period, should lead to a strong multi year period of outperformance.”
MSCI World Index versus global small/mid cap sector over the three years to 15 September 2020
