It would be wrong to compare last year’s surge in US tech stocks to the dotcom bubble, according to Dave Bujnowski of the Baillie Gifford American fund – but that is not to say there won’t be a “downdraft” ahead.
Bujnowski said it is important to make a distinction between the two, pointing out that a “downdraft”, or correction, is an inevitable part of stock market investing. However, while he said it is highly likely we will experience a “painful and acute” correction in the next few years, it is doubtful we will see a repeat of what took place in 2000 when the Nasdaq fell by 75 per cent over a period of three years.
Performance of index over 3yrs
Source: FE Analytics
And the manager said the difference is fundamentals.
“That's really the point I want to drive home,” he said. “Downdrafts can be emotional and fleeting, something I'm inclined to look through.
“A bubble bursting has an element where fundamentals come to a screeching halt and it can result in more lasting damage.”
The rally of the late 1990s is often regarded as a triumph of hype over reality, with share prices driven higher by a fear of missing out rather than any structural change at the business level. However, Bujnowski pointed out that in reality, there was a significant change in fundamentals as we entered the new millennium – they went backwards.
“In 2000, for instance, sales of PC units in the US fell 12 per cent,” he said. “That was the first ever year-over-year decline. Similarly, the compound annual growth rate for mobile phones was 60 per cent from 1996 to 2000, but in 2001 it fell by 3 per cent – again, the first decline ever.
“Networking equipment – Cisco grew robustly for 40 straight quarters. But in the third quarter of 2001, sales fell 30 per cent year on year.
He added: “Bring it forward to today. What we do as a group is focus on fundamentals on a stock-by-stock case. Every company in the portfolio has a forward-looking hypothesis, that 2.5x upside case. We'll take a look at a forward-looking hypothesis that we believe in, map out the valuation needed to make 2.5x upside over five years, then make an honest assessment as to whether there is a likelihood that that 2.5x case can happen. And if not, it's a sell trigger.
“It's less about the market, a bubble or high valuations for tech stocks, and more about case-by-case, are fundamentals intact, do we have high confidence in them, and is there still room for upside over a five-year period?”
Rather than declining as they did in the early 2000s, Bujnowski believes the fundamentals of many stocks in the US market can improve from here. The manager wrote a paper in Q3 2019 titled ‘A Case for Growth’ in which he rubbished the idea that a value rally was imminent following a decade of outperformance by growth stocks.
At the time, he accepted that swings from growth to value and vice versa were common to ‘normal’ economic cycles, but said that in a period of enormous disruption and upheaval, the idea of a reversion to some notion of intrinsic value was misguided.
The growth stocks in Baillie Gifford American have surged since then, with the fund up 121.84 per cent in 2020. Yet despite the elevated share prices, Bujnowski said his conviction in his original thesis has strengthened.
Performance of fund vs sector and index in 2020
Source: FE Analytics
“That's because the force that's behind the run has nowhere near played itself out,” he explained. “In fact, it's intensified. And that force is disruption. We are living in an era of unprecedented disruption.
“Of course, the idea of disruption has become well publicised over the years and it's hardly a novel narrative. However, we believe the entire dynamic is still tremendously underappreciated, specifically just how many disruptive forces are happening in unison and how potent and early they still are.”
To illustrate his point, he highlighted two disruptive forces that have already had an enormous impact on the way we live and work, but that are still in their infancy.
The first of these is what he calls “infrastructure changeouts”. The premise here is that when infrastructure changes, the businesses and industries that rely on it weaken and there is an opportunity for innovators to enter and build on the new way of doing things.
“The thing is, infrastructure doesn't change often,” Bujnowski continued. “But today we're in the midst of two massive infrastructure changes: the internet, upon which commerce, media and information flow; and the cloud, upon which it is stored, powered and distributed.
“Between the two, we're talking about virtually every corner of the economy and society. I know what you're thinking: ‘The internet and the cloud, haven't we heard this all before?’
“It might seem like old news, but I'd highlight two things. First, it's still early. E-commerce is still just 15 per cent of all retail in the US, with some large categories far less penetrated. As for the cloud, only 15 to 20 per cent of all apps or workloads have migrated there so far.”
The second is the knock-on effect – or to put it another way, how disruption leads to more disruption – and Bujnowski said this is an even more powerful force than the change in infrastructure.
“The knock-on effect in this case involves the topography of these new infrastructures,” he continued.
“The internet and the cloud are hyper-connected networks. The magic here is that when a system transitions from being not so networked to hyper-connected, it plants the seeds for network effects: winner-takes-most dynamics and increased returns to scale.
“Now of course, we've seen this play out with companies like Amazon, Google and Facebook and their respective markets over the years. These companies are often thought of as anomalies, outliers. And to some degree, they are the result of extraordinary vision, powerful strategies and superior business models all coming together. But I'd argue that the extreme nature of their success could simply not have happened if not for the network nature of the systems in which they now participate.
“And here's the punchline: That system, that hyper-connected network isn't confined to the so called FAANG stocks, it's everywhere. It sets the table for more outliers to emerge.
“And we suspect some are still just germinating.”
Data from FE Analytics shows Baillie Gifford American has made 945.58 per cent over the past 10 years, compared with 291.86 per cent from the S&P 500 index and 244.37 per cent from the IA North America sector.
Performance of fund vs sector and index over 10yrs
Source: FE Analytics
The £7.8bn fund has ongoing charges of 0.51 per cent.