A High Tech Boom from Another Era

One of the greatest pairings for the past several years has been the Long Nasdaq/Short Russell 2000 trade. This High Technology/Main Street spread trade made fortunes for momentum oriented investors and decimated value traders who believed that valuation actually matters. Recently however the spread has run into a wall of resistance as the Nasdaq advance has slowed with Russell starting to outperform.
As the new year begins we try to answer the age old question – will value will be valuable once again?

Buy (Long Nasdaq/Short Russell spread keeps working)

The Winner Takes All Economy Continues

The biggest reason for why High Technology laden Nasdaq has been such an outperformer is because its largest companies enjoy near monopoly-like positions in their respective fields. #AMZN #FB #GOOGL not only dominate  but crush competition collecting more that 80% of any marginal dollar of profit in their sector.

High technology economy is governed by the network effects law which states that as the network of customers expands it becomes too expensive to challenge the incumbents  leaving all the profit to industry leaders. 

There is little reason to believe that this dynamic will change in 2021 which means that the high technology sector will continue to be a cash cow for investors.

New Markets New Profits

The high tech companies not only enjoy monopoly profits but are constantly seeking to expand their reach into other markets. #AAPL is moving very aggressively into health and fitness with a combination of hardware and software offerings to grab a share of the trillion dollar plus medical market. #FB is exploring the possibility of social e-commerce via Instagram and WhatsApp and #AMZN is trying to tackle the pharmacy business before moving full force into healthcare. All of these are multi-billion dollar opportunities that could create new profit streams

COVID Changes are Here to Stay

The radical changes in consumer behavior from contactless retail, to virtual meetings, to a more home-centric life may be here to stay. These new ways are not only considerably more convenient but far less expensive as well indicating that the rapid adoption during pandemic will continue in a post COVID world as the transformation from physical to a virtual world touches very aspect of our life.

Sell (Long Nasdaq/Short Russell spread stops working)

Valuation is Sky High

No matter the greatness, no matter the growth, no matter the dominance stocks always succumb to valuation adjustments in the end. One needs to only look at the chart above to note that this time it’s never different. #KO #WMT #MSFT spent decades in the wilderness despite continuing to make money and grow market share because their stocks were so grossly overvalued in late 90’s. With some of the Nasdaq leaders sporting triple digit P/E ratios its just a matter of time before they come crashing back to the ground.

Regulation is Coming

Success attracts government oversight and with the new Biden Administration about to take power high technology may be under attack from both sides of the Atlantic as regulators seek to curb their growth on antitrust grounds. Even if the tech companies manage to beat the Feds the battle scars are sure to leave a bruise and could force management to take their eye off the business. #MSFT is the poster child of this problem making shareholders no money for more than a decade as it struggled to find its way after enduring an antitrust lawsuit from the US government

Operational Leverage.

After years in the wilderness and a near death experience during the pandemic lockdowns many of the “real” economy companies that have survived have cut their costs to the bone. If the COVID threat recedes they could see a big pick up in demand from two key drivers – the return to more physical transactions which will help high touch businesses like restaurants entertainment and hospitality and infrastructure build which is a key plank of the Biden Administration.