How might technology stocks perform in 2021

By Bob Huxford

Technology markets went on a tear in 2020. The value of the NASDAQ increased 43.6% in 2020, a smidgen below its best year ever of 2009 when it grew by 43.9%. However, 2009 was a bounce back from the financial crisis of 2008 when the index declined 42%. 2020 wasn’t a bounce back from anything. The NASDAQ had already recorded 27% growth in 2019. 

That’s a pretty impressive performance given a lot of commentators were already thinking tech valuations were heated at the start of 2020. And there was the small matter of 2020 being a year in which we endured a global pandemic that killed almost two million people, caused huge increases in unemployment and ravaged economies. The US, where NASDAQ companies are typically headquartered, was one of the hardest hit.

Many people see this seemingly perverse outcome as evidence that tech valuations have become divorced from reality and envision a sharp correction in 2021. 2020 should have looked more like 2008 rather than 2009. However, it’s not necessarily the case that technology is overvalued, let alone grossly so.  

Firstly, although technology has outpaced other sectors, the wider market has also rebounded strongly since the sell-off back in March. Huge economic stimulus from government combined with low interest rates has increased the value of most all long-term assets, not just equities, with gold, property and cryptocurrencies, all performing exceptionally well during what on the surface has been a year of economic crisis. The stock market is also a measure of future rather than present value, so with vaccines being rolled out across nations there is the clear expectation we will soon be past the worst.

Secondly, a lot of technology companies have had a very good 2020. The inexorable shift toward digitisation was accelerated by the pandemic and this has been borne out in some excellent results. It has typically been smaller businesses with less access to funds that have suffered most from the pandemic. A business has to be of a reasonable size before listing and meet certain liquidity criteria so will often have a stronger balance sheet than smaller unlisted competitors. The listing itself, of course, also provides access to capital through the ability to raise funds in the market. One sad fact is that the rise in the share prices of many technology companies may be in part due to them acquiring less well-financed, pandemic-hit competitors at bargain prices, or seeing smaller challengers simply wiped out entirely.

Thirdly, although share prices of tech companies are higher than ever before, forward valuations aren’t actually that far ahead of the norm. The NASDAQ’s PE ratio today stands at 24.2, only marginally ahead of where it was at the start of 2020, at 22.7, and a good deal lower than it was three months prior to that when it stood at 30.7. There are some notable outliers within the Nasdaq; Tesla has a stratospheric forward looking PE of 171, and Apple is higher than most at 33 times 2021 earnings, but overall the index is pretty much business as usual.

So what might 2021 hold in store for tech valuations? As mentioned above, conditions are generally favourable for listed tech companies. The pandemic has strengthened their market position through removing competition, the consequences of which will be long term. The move to digitisation will continue, although this may slow somewhat if the vaccine rollouts prove successful. In addition, interest rates are at historic lows which greatly suit the expansion of the recurring revenue models of tech companies.

There are many risks for technology valuations though. An end to quantitative easing being a key one.  However, that doesn’t look to be imminent. Another $900 billion stimulus is being pumped into the American financial system as we speak and there are calls for much more. Biden may be pressured to revisit the $2.2 trillion stimulus that was initially earmarked.

Increased regulation is also a key threat with Biden having already promised greater scrutiny of mega-tech companies which are widely seen as having monopolies over their respective industries, hobbling competition. His ability to push such measures through is also growing with today’s (as I write) Georgia run-off pointing to a Democrat led Senate which was previously expected to be Republican. US markets have just opened with big tech stocks all falling in reaction to the news. The NASDAQ is up however.

A blue sweep would also raise expectations of a tax hike, removing Trump’s low tax regime which has long benefitted tech stocks. However, any margin the Democrats do gain in the Senate will be razor thin and so Biden will still likely struggle to push through policy. Also, any regulatory changes or plans to break up the big tech companies will likely take a long time to come to fruition. Furthermore, a Democrat led Washington would make further stimulus more likely, which again could benefit technology valuations.

Another risk is that there is a rotation of investors’ money out of technology stocks and into other areas of the market. It is only natural that investors cash in on their big winners from 2020, such as technology, and seek the best value opportunities elsewhere. This risk is tempered to some extent by the fact that this already appears to have been happening over the past few months with expected economic expansion driving a move into value stocks. Value stocks had outperformed growth stocks for five weeks in a row by mid- December, the first time this had happened in two years.

On balance, technology valuations could gain further ground in 2021. A repeat of 2020 would be highly unlikely but growth could potentially be double digit. The NASDAQ has delivered three years of double digit growth in a row on four separate occasions in the past so it is more than possible.  Smaller cap tech stocks have also been performing well since November, having previously lagged the giants, and this is a trend that will likely continue into 2021. 

Ultimately, the fundamentals of many technology companies remain strong and so support solid valuations. Although the market caps of some of the bigger tech companies may appear obscene these are typically brilliantly managed, hugely well-capitalised businesses with platforms and products that have become an essential part of our everyday lives both at home and at work. They really should command a bit of a premium. In the event of an upset then there is the potential for highly valued technology companies to take a bit of a pummelling but if these can be avoided then the current environment favours continued growth.