The last week’s dramatic fall in the value of US technology stocks is the biggest correction since the market upheavals in February and March. Investors should welcome the partial retreat - it makes a bigger crash further down the track less likely.
August was the best summer month for investors since the mid-1980s. Shares rose on the back of central bank and government stimulus, a brightening outlook for earnings and the hope that the worst of the pandemic was in the past.
Some of the gains were justified, some were wishful thinking. But the scale of the rise since March, and in particular its narrow focus on just a handful of technology names, ensured this was a fragile rally. No-one should be particularly surprised that some air has come out of the bubble.
The nature of rally, fuelled as it was by large-scale purchases of so-called call options - bets on continued rising prices - made the gains even more vulnerable to a correction. Buying of actual shares to hedge against the derivatives positions meant the rise in tech stocks had become self-fulfilling and divorced from the underlying reality of earnings.
This kind of one-way traffic is never sustainable and this week’s fall in the tech-heavy Nasdaq index takes the decline since last week’s peak to more than 10%. That’s the traditional definition of a market correction.
Two-thirds of the stocks in the Nasdaq index fell, including some spectacular declines, such as the 21% fall in the value of electric car maker Tesla. Apple fell nearly 7% and Microsoft lost more than 5%.
Again, no-one should be too surprised by the scale of these falls. The gains that preceded them over the past six months have also been out-sized. Apple was briefly worth more than all the companies in the FTSE 100 index and more than all the constituents of the Russell 2000 US smaller company index.
Tesla is worth more than long-established car manufacturers churning out many more vehicles than Elon Musk’s company could dream of doing.
Also unsurprisingly, the value of Softbank, the Japanese company behind much of the speculative buying of US tech shares, has tumbled this week too.
So far, the damage has been largely restricted to the tech sector. The S&P 500 suffered a 2.8% fall earlier this week because it also has a high exposure to technology stocks. Other markets around the world have largely avoided the fall-out.
This makes some sense. The valuation of the top US tech stocks is now close to the levels reached at the height of the dot.com bubble 20 years ago. As investors with longer memories will recall, that situation did not end well. In the years between 2000 and 2003, the previously unfashionable ‘old economy’ stocks, that had lagged tech in the boom years, outperformed significantly.
Maybe we will see a repeat of that reversal of fortunes. The uncertainty is a good argument for broad diversification across different investment styles. Investors will also hope that a modest fall in prices today can help avoid a bust like the one that ended the long bull market of the 1980s and 1990s.
The timing of the correction is interesting for followers of the old investment adage: Sell in May and go away, don’t come back ‘til St Leger Day.
The horse race meeting of that name is scheduled to be held this Saturday and many investors will be wondering if the saying has been turned on its head in 2020. Rather than sitting out the summer and getting back into markets in the autumn, the better strategy this year may well have been to enjoy the ride from May to September and to become more cautious, not less so, as the evenings draw in.
Our guidance, as ever, is to avoid the temptation to try and time the market either way. Predicting the ups and downs of the stock market is a fruitless task and it is invariably a much better approach to keep dripping your savings into the market through the cycle.
Interestingly, there are still optimists making the case for continuing to invest in the market at today’s levels. Goldman Sachs, in particular, has drawn up a long list of reasons to remain cheerful.
It believes we are in the early stages of a market upswing that was born out of the wreckage of the short but savage bear market in February and March this year. This ‘hope’ phase of the cycle is very often one of the strongest periods for investors.
Goldman’s analysts and economists have also raised their forecasts recently. They are bullish on the prospects for an early vaccine, despite today’s bad news on that front from AstraZeneca. And they expect central banks and governments to remain supportive.
Other reasons to be positive include the likely continuation of low interest rates, which make shares look cheap compared with bonds and encourage more risk-taking by investors. The bank also continues to believe that the digital revolution, which has seen tech stocks emerge as the biggest beneficiaries of the pandemic, has a long way to run.
So, there are reasons to be positive and reasons to be concerned right now. Other than with the benefit of hindsight, that is usually the situation. The best protection against this uncertainty is diversification, strong nerve and patience.
Five year performance
As at 8 Sept
Past performance is not a reliable indicator of future returns
Source: FE, total returns as at 8.9.20, in sterling terms
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