US technology share prices have maintained their breakneck upward pace so far in 2018, with the so-called FAANGs -- Facebook, Amazon, Apple, Netflix, and Google -- up almost 29% each on average.
Collectively they are on track to match the 40% gains recorded in 2017, far outstripping the year-to-date 6.7% gain in the broader S&P 500 and even the 13.1% rise in the tech-heavy Nasdaq.
Individually, some of the FAANGs are doing better than last year. Indeed, two of them -- Amazon and Google owner Alphabet -- recently became the world's first trillion-dollar public companies as investors bet on their continued strong earnings.
Despite the heady performance -- or perhaps because of it -- investors should pay close attention over the foreseeable future to the broader risks disseminating from the sector, thinks Alistair Barker, head of portfolio construction at AustralianSuper.
“It’s a very large sector and the direction of technology will be one of the key drivers of how strong equity markets can be over the next 24 months,” Barker told AsianInvestor.
It's also a highly concentrated sector facing new and growing challenges, he noted.
The European Union (EU), for example, has recently imposed regulations that cover the handling of data and data security, and some technology companies face governance-related challenges that could potentially impact future earnings.
In May the EU began enforcing its General Data Protection Regulation (GDPR), which regulates how a company processes personal data inside the bloc, regardless of a company’s location. Facebook and Google were immediately served with lawsuits for a combined $8.8 billion by European digital rights group NOYB.
The EU also fined Google $5 billion in July for breaking antitrust laws in regards to its Android mobile operating system. This follows a $2.7 billion fine in June 2017 that targeted Google’s practice of including its own Google Shopping results in its search engine.
And there may be more trouble to come, with the European Commission looking at a third case where they’ve already concluded that Google imposed illegal terms on Android device markers, according to Eoin Murray, head of investment at Hermes Investment Management.
“We know there’s a third fine for Google coming. We just don’t know how big it is and we don’t know quite when the commission will announce it,” Murray told AsianInvestor.
Murray is also keeping an eye on US Department of Justice special counsel Robert Mueller’s investigation into possible Russian involvement in US President Donald Trump’s election campaign, and how that might impact the tech sector.
Mueller is expected to go public at some point later this year, or early next year, with the findings of his investigation into Russia's alleged inteference in US politics and the role social media may have played in that, he said.
“To what extent will the Cambridge Analytica case land at the door of Facebook, and will there be a fine associated with that?” he added.
In April 2018, Facebook revealed that data from as many as 87 million users was improperly shared with Cambridge Analytica, a political consulting firm that worked on Trump's presidential campaign.
WHY IT MATTERS
These risks in the tech sector matter because the positive story of the last 12 months in equity markets has really been driven by the strengthening earnings growth of technology companies, Barker said.
“The ability of technology to help equities break new ground is going to be a pretty critical driver over the next little while,” he said.
Tech stocks also feature quite prominently in the global equity benchmarks tracked by many fund managers, with technology and IT firms making up 19.31% of the MSCI World Index, 26.5% of the S&P 500, and 45.44% of the Nasdaq Composite Index.
For AustralianSuper, which this year is lowering its allocation to domestic equities and increasing its allocation to international shares in its Balanced fund, any adverse impact on US tech stocks would have a reasonably material impact on its portfolio, Barker said.
For now AustralianSuper isn’t planning to take remedial defensive action, Barker said -- an attitude shared by other institutional investors.
Hermes’s Murray said investors are probably aware of the risks but have been happy to ignore them while tech stocks do well.
“It is very tempting to see these stocks in isolation; it’s difficult to bet against them,” he said.
Some investors, however, maybe are rethinking their allocations -- an August report by Bank of America Merrill Lynch showed outflows of $500 million from the tech sector in mid-August, the largest outflow since February.
At the moment the impact of the data regulation and governance concerns is not huge, and for companies that are FAANG-sized the fines are drops in the bucket. But the figures are rising, Murray notes.
“I don’t for a second believe that somebody like [Amazon chairman and chief executive] Jeff Bezos is so complacent that he will be ignoring these numbers, even if they’re relatively small at the moment – it could easily get a lot bigger,” he said.
As it stands, tech stocks present more of a medium- to long-term risk, Murray said. Even so, investors should be careful not to ignore them.