Amid concerns the dominance of technology stocks, particularly the artificial intelligence (AI) rally, is reminiscent of a second dotcom bubble, Global X’s head of investment strategy, Scott Helfstein, said he believes there is more to the story than meets the eye.
Helfstein remains optimistic about the burgeoning “innovation economy”, noting that the tech sector today trades at 30 times price to forward earnings, compared to the S&P 500’s 20 times. This contrasts sharply with the “exuberance” of the 90s, when the tech sector traded at 80 times price to forward earnings while the S&P traded at 30 times.
Helfstein noted that unlike the prior dotcom era, today’s figures reflect years of investment in automation and digitisation, resulting in more efficient businesses.
“If we think that there is exuberance in the market […] this to me is a rational move, because we have more productive companies,” Helfstein explained at a recent media briefing in Sydney.
Looking more broadly at the historical performance of the S&P 500, he observes US large-cap stocks tend to “move higher in waves”.
“US large-cap stocks, they go up in bits and starts. We plateau for a while, we get a high, we plateau for a while, and then we break out to new highs. Typically speaking, by the way, those plateau periods last about three years, and then we move into an expansion period. Expansion to new highs, on average, lasts about two years, and returns roughly 50 per cent in that period of expansion,” he said.
“We crossed into a new high a couple months ago, we’re two months in, and we’ve returned about 8 per cent since then.
“So, if you want to ask me which way the market’s going, I don’t think we’re heading towards another plateau.”
Instead, current markets, despite margin expansion, are experiencing a “much, much better version” of the dotcom era.
“There are a couple of historic events that we have now lived through in the corporate landscape, which I think go underappreciated. Number one is, for 13 straight quarters, S&P500 companies have delivered profit margins above 12 per cent. That has never happened before. Companies are so much more profitable, just over the last four years,” Helfstein said.
“And why does this matter? Because valuations follow profitability. If someone is more efficient at making money, we should have to pay more to own it.”
He noted that it took 75 years for average margins to grow from 6 to 9 per cent, while in the past 13 quarters alone, margins increased to 12 per cent, a leap that previously took three-quarters of a century.
Importantly, these margins have been accompanied by 10 consecutive quarters of double-digit capital expenditure, showcasing how companies have invested in improving efficiencies since the start of the pandemic.
“What are companies investing in? They all say the same thing, it’s automation and digitalisation. It’s automation so that they can deliver our products more efficiently and cheaper, and it’s digitalisation so that they can better connect with their customers and they understand their businesses better,” he added.
Over the last quarter, some of the tech giants comprising the “Magnificent Seven” have reported significant rises in capital expenditure. Namely, Microsoft’s capital expenditures rose to a record $14 billion in the March quarter while Alphabet, the parent company of Google, reported capital expenditures of $12 billion.
In this context, Helfstein predicts that markets will continue to witness “tremendous growth”, coupled with enhancements in margins and profitability, as the world enters its fourth innovation boom since the 1960s, following the introduction of the mainframe computer, personal computers, and the commercialisation of the internet.
“Fast forward to AI, and it’s not a consumer-led technology, it’s a corporate-led technology, and the first impact we are going to see is company efficiency,” he remarked.
Earlier this month, Martin Conlon, Schroders’ head of Australian equities, outlined a more conservative view regarding the “astonishing” valuations of the Magnificent Seven.
“Anyone who has been around for a while, and it depends on what paradigm you’re used to in investing, but most older people who have seen some market cycles look at multiples today and say, ‘These are high’. They make you worry,” he said at a recent media briefing.
“Most younger people are sitting there saying, ‘Don’t worry, all I have to do is buy global compounders at any price and I’ll be fine’. I look at that and think, I don’t see that logic at all.”
