With the Fed set to increase interest rates this month we are holding on to our technology winners within our equity portfolios
Inverted yield curves may point to slower economic activity
We welcome the Fed’s intention this year to try and normalise monetary policy. However, we notice the strange phenomenon within US bond markets that the yield curve has continued to flatten and is now back at the level prevailing in September last year. Normally a flattening yield curve is indicative of slowing economic activity.

Figure 1. US Yield Curve
Source. Bloomberg, CLSA
As equity investors we have to question ourselves whether the bond markets are giving us a warning of impending weakness in economic activity. Equity markets in Europe and Asia are off to a strong start this year with double digits $US gains. If equity markets are any indication of investor optimism for the economic outlook for these regions, one could argue that the yield curve is giving a false signal of slowing economic activity and it would be best to ignore this signal. The confusing signals from the bond and the equity market continues to baffle investors.
Technology companies should continue to grow even if the global economy slows down
As stock pickers we continue to focus on long-term growth prospects for individual industries and companies.  We believe that within the wider technology sectors certain sub sectors continue to offer investors long-term opportunities to invest and grow capital. International Data Corporation estimates that annual data creation will increase tenfold and data analytical requirements by 50-fold by 2025.
More specifically, Gartner forecasts that by 2021 the size of cloud-related revenue opportunities will increase threefold. Companies that will continue to benefit from these trends include Microsoft and Oracle, where we have been invested over many years. For software companies in particular, the high opportunity cost to their corporate customers that results from not keeping up with product cycles gives technology companies a lower sensitivity to downturns in economic activity.
Besides the obvious growth opportunities for many of our technology investments there are several other advantages within the sector:

  • Technology is oligopolistic: Barriers to entry include the scale of research and development investment, the ability to create, analyse and own data as well as network effects. This is relevant for companies like Alphabet and Tencent as well as Alibaba.
  • Strong balance sheets are noticeable across the technology sectors with the industry collectively in rude health.  The graph below shows that sectors like Utilities carry relatively high levels of debt in order to fund capital extensive projects governed by regulatory obligations.  We have no exposure to utility business in the equity portfolios we manage.


Figure 2. Global L2 Sectors Net Debt/EBITDA
Source. Thomson Reuters, Credit Suisse Research
Strong balance sheets allow our technology businesses to make opportunistic acquisitions. In the case of Oracle the company is acting in a very typical way in that the management has the ability to buy competitors due to its strong net cash balance.
Per Credit Suisse companies like Facebook (not owned) and Google collect about 53% of advertisers’ total global digital advertising spend (circa $128bn in 2017) and more importantly around 85% of incremental net ads. The incremental benefits to these companies are enormous as free cash flow continues to grow whilst they are still investing heavily in research and development to stay ahead of the competition
One area we continue to avoid is semiconductors. An analysis of valuation based on relative price to book value would point to overvaluation in the short-term. We sold our position in Samsung some time ago.

Figure 3. Global Semiconductor: Price-to-Book value relative to market
Source. Thomson Reuters, Credit Suisse Research