Tech and Scottish Mortgage - bubble, trouble or double?

Recently your questions have been coming in thick and fast about the outlook for the tech sector in general. Along with some pretty specific questions on perennial DIY investor favourite, Scottish Mortgage. One of you wrote to me, “I – like many others I’m sure – loaded up at the start of the pandemic and now have a fairly languid fund in the red in my portfolio. It’s ticking back up (largely driven by Nvidia) but I’d be interested to hear your thoughts on the fund and sector more in general”.

Your wish is my command. This week I’ve been in the City and on Zoom, talking to investment experts about these two questions.

First, what about markets – and tech – in general?

On Wednesday, I had lunch with James McManus, who is the Chief Investment Officer for Nutmeg. In a nutshell, he remains pretty bullish on both the prospects for technology and the US stock market in particular.

James talks about a ‘broader industrialisation of technology’ – which roughly translates to the fact that technology is everywhere as a facilitator, no longer simply quarantined as a sector. So Amazon isn’t a tech firm, it’s classified in investment speak as ‘consumer discretionary’ (stuff which Jo Public wants but doesn’t need); Netflix is also ‘consumer discretionary’ and Facebook is a communications business. When we look at the world through this lens, maybe we are less exposed to the pure tech sector than we think?

We also talked about the fact that the last 10 years have not been normal. Perhaps unfairly, I asked James to elaborate as I started to eat his chips, seizing my opportunity. Maybe, I said, this time it really IS different? Gobble, gobble…

Let’s look at what’s been going on. The S&P 500 has done better than a more broadly diversified portfolio would have done – so actually diversification of regions hasn’t really worked of late. Growth shares (things like tech) have done really well despite high interest rates, and value shares (boring companies which make money today, but which won’t have massive growth spurts in future) have done relatively badly. And smaller companies have done worse than the Big Dogs. This has been the case for quite a long time and it feels difficult to argue that any of this will change in the imminent future.

Maybe this bubble isn’t very bubbly?

The other big difference to the current ‘tech boom’ compared to the previous dot.com bubble we saw 25 years ago (God, am I that old?!) is that the tech companies today are actually making shed-loads of money. Nvidia is still rated a Buy by many investment banks today based on how much revenue they're likely to generate in future. And with a monopolistic-type grasp on the first rung of the AI commercial ladder (i.e. you need them to move up to the next stage of AI commercial opportunities), it’s actually impossible to say for sure that Nvidia is overvalued.

As I finished off the chips (the potato variety), the summary from James seemed to be a reminder that we still need to diversify. BUT large US tech stocks are well-positioned for yet more growth and some ‘tech’ stocks are in fact just retailers, communications companies or consumer products, so we may actually be more diversified than we think.

I asked Emma Wall, Head of Investment Research and Analysis at Hargreaves Lansdown, for her take. She thinks it’s pretty hard to say whether US tech is in a bubble. “Given the market has been led by just a few names and valuations continue to rise, it’s easy to see why it appears to look like a momentum-led bubble. But generally, the companies whose share prices have risen the most have been supported by growing earning, Nvidia being a key example of this. Whether these companies can continue growing their earnings into the future is harder to know and depends on a variety of things such as the continued advancements in AI and the health of the consumers. If earnings start to slow then you could see a sharp reversal in some of these names”.

Although compliance prevents anyone in a large financial firm from appearing too enthusiastic, even about chips, this sounded quite positive to me.

And what about Scottish Mortgage?

(Scene set – for readers who don’t know them, they're based in Scotland, have nothing to do with mortgages, and are a bunch of smart people who try to build a collection of the world’s most exceptional companies for us to invest in, in a single ‘ready-made’ investment playlist you can buy online called an ‘investment trust’. It went gangbusters for many years and was a bit like jam – everyone loved it; had a bit of a shocker post-Covid and became Marmite; and is seemingly on the up now but a bit like peanut butter – some love it and a few are allergic to it which is why it is trading as what is called a ‘discount’).

Emma Wall reminds us of what the hoopla is all about. “Since current manager Tom Slater joined the trust in August 2009, it has returned around 975% compared to circa 480% of the benchmark. He has clearly been able to add alpha (Holly note: this means how much better than the average you are) over the very long term. The fund could also have some macro tailwinds should interest rates begin to fall”.

I talked at length to Scottish Mortgage product specialist Claire Shaw yesterday and you can read my honest opinion here – and what I’m planning to do with my holding. [Spoiler alert – for those with long-term timeframes, I think it’s still a good pick for a part of your portfolio.]

What’s in it?

Here’s a few snippets I will pull out. They observe some deep underlying structural trends which even cave dwellers in the Outer Hebrides will have noticed, and of course the common denominator is technology and artificial intelligence. This does not mean the trust is focussing on pure play technology stocks – in fact they say they're borderline underweight the global index when it comes to technology. But they seek out companies which use it to deliver exceptional performance and growth in their field.

One example is Joby Aviation. The Joby Aviation S4 is a silent, battery-operated aircraft, which has a top speed of 321kph and capacity for a pilot and four passengers. It’s an electric air taxi. It’s been agreed that operations will start by early 2026 in Dubai. How bloody cool is that? Could I put in a request for Eastleigh Borough Council to join the queue please – the M27 needs a bit of Joby-fication.

Another example. Zipline is a drone manufacturer which is exploring using drones to deliver healthcare in Africa. And of course there is Nvidia, the ‘picks and shovels of AI’, which Scottish Mortgage are quick to observe they have owned for many years. This chip maker is enjoying monopolistic-like profits at the coal face (chip face?) of AI development, but what’s next? If Nvidia is phase one, then phase two is the infrastructure – the cloud providers and security software. And phase three are the companies which stand to make more revenue as a result of AI. The trust owns companies in these phases too.

Although this technology is all very exciting, analyst Alex Watts at interactive investor is broadly positive, but notes the need for caution “… investors should be cognisant that such high commitment to one particular theme can make for a volatile ride. Technical constraints in AI models or a down cycle of demand could create short-term stress for SMT’s zealous allocation to companies involved in the hardware, infrastructure and application businesses behind AI”.

And so what?

I have owned a bit of this trust for years. And I’m not selling now, even after the pain of the last 3 years. (The biggest detractor was Moderna, but like a disappointing teenager coming out of a vile few years, Claire explained why they still love her and how she’s maturing nicely).

So… Deep breath. I feel quietly reassured this week. On the ‘tech bubble’. I might feel less happy if interest rates don’t start to come down. But ultimately this comes down to your perspective on how much AI will drive revenues in future. If you believe the more bullish forecasts, then the valuations today look OK. If you don’t, they look toppy.

For what it’s worth, I’m holding the Scottish Mortgage faith and my detailed article shares why. But reader, draw your own conclusions – I also chose a poster of Shakin’ Stevens over Adam Ant for my bedroom in 1984. And the most cursory glance at my ex-boyfriends will remind you that my decision-making process is not infallible!

For those of you after something very different to the tech sector, this piece from Polar Capital reviews the banking sector, and if you want something regionally different to the mainstream US, Blackrock’s Frontier Investment Trust serves up Indonesia, Kazakhstan and Vietnam amongst others! And last but not least, as part of an upcoming series for the self-employed, there are some tax-busting tips for you.

Have a great weekend everyone.

Holly

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