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Digital is the new norm

Asia Analytica
Asia Analytica • 9 min read
Digital is the new norm
We do not doubt that there are indeed many tech stocks that may well be trading at irrational and unsustainable valuations.
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Technology stocks are riding high on strong upward momentum worldwide. A case in point: The Nasdaq Composite index gained 43.6% in 2020, far outperforming both the Dow Jones Industrial Average and Standard & Poor’s 500 index, which were up 7.2% and 16.3% respectively. Tech stocks have continued to rack up gains in the first few weeks of 2021, again outpacing the broader market.

Against the backdrop of the Covid-19 pandemic — which has hit many businesses, especially those in the services sector, hard — tech stocks were rightly seen as a safe haven. Indeed, many benefited as businesses and consumers shifted from the physical to digital worlds.

We have written about how e-commerce, digital banking and e-wallets, on demand and streaming gaming and video, cloud services and so on have helped people maintain some semblance of normality for both work and leisure during the extended periods of restrictive movement measures.

Unsurprisingly, the strong gains have many believing that tech stocks are in a bubble, perhaps even on a par with the dotcom years between 1995 and 2000. In fact, the financial media is filled with narratives highlighting the fact that tech and broader market valuations, by almost every yardstick, are currently well above historical ranges.

We do not doubt that there are indeed many tech stocks that may well be trading at irrational and unsustainable valuations. It is bound to happen. A rising tide lifts all boats. We think, however, that people are also underestimating the massive positive impact that the unfolding digital transformation will have on people, businesses and global economic growth.

That said, while the macro trend is clear, selecting the winners will be difficult. We are at the starting line where there will be many players hoping to capture the anticipated growth. Which streaming service providers will pull ahead in the increasingly crowded field? Which cloud infrastructure and service providers will prevail against the competition? Which cybersecurity systems and which e-commerce platforms will be the eventual winners? For some industries, the winners may be those providing agnostic platforms while for others, closed systems will be better.

Unlike the past industrial revolutions, where there were many winners in every sector, competition in the digital space might well be different. For certain sectors and applications, the endgame could be that of a winner takes all. This is because of network effect plus a very steep supply curve — the initial cost of development is high but marginal cost falls rapidly, even approaching zero, with each new customer and sales. Which of the digital sectors will fall into those with few players and which will have many?

So while there will be many hugely successful companies, where their stock prices will skyrocket and yes, where PE multiples may even be in triple digits, more will fail although they may appear promising — even within the same sectors, providing similar goods and services.

This would be something that is never before seen in the capital market — stock prices skyrocketing and collapsing at the same time for companies operating in the same sector. Against this landscape, the line between good and mediocre analysts will become even more apparent — and this is where knowledge becomes even more valuable. If nothing else, this is why “content will remain king”.

During the dotcom years, many internetrelated start-ups were sold on innovations, ideas and concepts, with no real business model. The excessive speculation ultimately led to the bubble bust. But let us not forget that significant real value was created during this period.

Amazon.com, Google and Netflix were founded over the period of 1996 to 1998 whereas Facebook and Tesla started in 2003/04, right after the stock market trough. The first iPhone was launched in 2007, a key turning point for Apple. That said, much of the value created stayed broadly within the tech sector and, to a certain extent, concentrated in a basket of stocks. A case in point: The current combined market cap of six tech stocks — Facebook, Apple, Amazon, Netflix, Alphabet (Google) and Microsoft — is $10.8 trillion. That is bigger than the annual GDP of Japan, the world’s third-largest economy; and their market cap gains in 2020 were larger than the GDP of the UK, the world’s fifth-largest economy. While a common comparison, it says nothing about valuations. GDP is a “flow concept” whereas stock value is a “stock concept”.

On the other hand, the current digital transformation, often characterised as the Fourth Industrial Revolution (4IR), will have massive positive impact across almost every business in every industry an every country. It is the coming of age of the Third Industrial Revolution that began in the 1970s, with semiconductors, electronics, mainframe computing, PCs and the internet.

The big ideas — previously confined to the imagination of Hollywood such as autonomous vehicles (though not yet flying cars), artificial intelligence (AI) and self-learning machines, robots and nanobots, and genetic engineering — are now reality. And, critically, the user cases are building up the economic case, and actual payout.

The speed of today’s breakthroughs and the breadth and depth of changes can be compared only with that of the first two industrial revolutions, which spanned the mid-18th century to the early 1900s. From the invention of the steam engine to power machines in farms and factories, where goods could then be distributed beyond the community using steamships and railroads, to gasoline engines, airplanes, electricity, radio and telephone — all of these had a profound impact economically, socially and culturally.

Think of how Henry Ford’s revolutionary modernisation and assembly manufacturing process resulted in the significantly faster and cheaper production of the Model T, which in turn created ripple effects well beyond the auto industry.

It made cars affordable to the average person for the first time, greatly expanding people’s mobility and opportunities in terms of employment, education and housing. Rising car ownership spurred government investments in infrastructure such as roads and highways, and in the process opened up new markets for other retail and services businesses, all of which then went on to create their own positive feedback loops.

The assembly line — division of labour and specialisation — remains one of the most widely used manufacturing processes for mass production. The increase in efficiency, productivity and reliability resulted in substantially lower costs. That meant more affordable goods and higher profits and wages, which in turn underpinned the virtuous cycle of consumerism, investments and innovations and wealth creation.

We see the same massive, wide-ranging impact with 4IR, which is the convergence of the physical, digital and biological worlds. The crystallisation and real-world applications of technologies such as AI, 5G, the Internet of Things (IoT) and machine-to-machine communication, nanotech and material science, quantum and cloud computing, 3D printing and additive manufacturing, biotech and genetic sequencing-editing, renewable energy and energy storage will bring about another great leap forward in terms of efficiency and productivity — lowering costs (at every level of the value chain) and raising profits for enterprises.

Higher returns on investment will attract more capital, spur investments and greater innovations across every business and industry, a chain reaction that will go on for years, likely decades, to come.

What the future will look like is hard to imagine and the impact is impossible to quantify in terms of dollars and cents today. Yes, the stock market rally is driven by extreme monetary policies and historic low interest rates. But we think globally, economic growth and earnings will continue to surprise on the upside —and catch up with stock prices. In other words, it would be a mistake to oversimplify by benchmarking current valuations against historical ranges. The exponential pace of technological advancement is unprecedented. Therefore, the past cannot be expected to predict the future. We ask readers to refer back to an article we wrote on tech stocks and valuations three years ago (“A PE ratio of 9 or 229 times says nothing about relative valuations” [Issue 812, Jan 8, 2018]).

For sure, there will be huge disruptions in the labour market. For instance, we suspect many existing jobs in low- and midskilled administrative functions, logistics, factory floors, wholesale and retail, sales and customer service and data analysis, to name a few, can — and will — be replaced with robots, digitisation, automation and algorithms.

Therefore, it is imperative for governments especially to manage the transition in a way that is equitable and inclusive, through regulations, redistribution of wealth (social safety nets), equal accessibility as well as extensive retraining and upskilling of the workforce. In the previous industrial revolutions, farmers successfully shifted to factory jobs, the majority of which were then migrated to the services sector. Through all these years of technology progress, the world has always managed to create more jobs than the ones destroyed.

Current rapid technological advancements and innovations will similarly create new products and services, new supply chains and ecosystems — and new job opportunities. And just like the previous industrial revolutions, we believe 4IR will ultimately bring about higher income levels and standards of living for the people.

The Global Portfolio ended 3.7% lower for the week ended Jan 27, amid profittaking in the broader market. Last week’s losses pared total returns to 51.5% since inception. Nevertheless, the portfolio is still outperforming the MSCI World Net Return index, which is up 35.4% over the same period.

All stocks in our portfolio closed in the red save for Ericsson (+8.1%), Johnson & Johnson (+3.4%) and Microsoft (+3.8%). The biggest losers last week were Builders FirstSource (-8.5%), Bank of America (-7.8%) and Taiwan Semiconductor Manufacturing Co (-6.8%).

Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.

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