Tech stocks continue to be a source of debate on Wall Street, with many fund managers blasting the runaway valuations while others dive in deeper and deeper. RBI Capital has been shorting tech for a few years but isn’t ready to stop because of how high the valuations have become. However, Alkeon Capital is of the opposite opinion. The fund believes tech stocks are significantly undervalued and set forth its arguments in its first-quarter letter to investors, which was reviewed by ValueWalk.
Alkeon Capital was up 18.17% for the first quarter.
Carlson Capital's Black Diamond Arbitrage Partners fund added 1.3% net fees in the first quarter of 2021, according to a copy of the firm's March 2021 investor update, which ValueWalk has been able to review. Q1 2021 hedge fund letters, conferences and more At the end of the quarter, merger arbitrage investments represented 89% of Read More
Alkeon prefers tech stocks
The fund's management believes that in 2018, the multiples of many high-quality growth stocks contracted and that the correction in the second half of the year "created a significant disconnect between fundamentals and stock market reaction." They also felt that low-volatility stocks became "overvalued at an extreme and unprecedented relative level.
Further, even though tech and healthcare performed better in the first quarter of this year, the fund's management still believes both sectors are trading at a discount to the rest of the market. Alkeon management said looking back to 1975, tech stocks are even trading below their historical average. In fact, they see tech as a sort of "defensive investment in light of its cost-cutting proposition to the end customer, superior balance sheet, low labor cost to sales, ongoing industry consolidation, and very low sensitivity to interest rates."
The fund's management even goes so far as to describe the tech sector as "one of the cheapest in the S&P 500." They base this argument on the strong earnings growth put up by so many companies in the sector. Their argument also centers on business reinvestment as a percent of sales, which they believe enables tech companies to keep the barrier to entry high in their industries.
Tech as a defensive sector or bond proxy
Alkeon goes on to explain why they feel the tech sector is a defensive sector or almost like a sort of bond proxy. The fund's argument is timely in light of the current interest rate environment and possible investment in infrastructure. Management explains that tech investment performance hast historically been yield-agnostic for the most part "as statistically there has been almost zero correlation between the performance of technology subsectors and bond yields."
Because of this, the fund adds that tech has historically outperformed during times of both falling and rising bond yields. The Alkeon team believes this reflects the "product-specific nature of earnings growth for many technology stocks." They add that this frequently decouples their growth trajectory from the economic cycle, especially when it comes to key disruptors because new innovation often "overwhelms the economic cycle."
Increased tech spending expected
The Alkeon team also expects the tech sector to benefit for the next several years from increased spending caused by an emerging labor shortage in the U.S. They note that the U.S. population between the ages of 16 and 64 is expected to drop off sharply over the next few years and even turn negative by late 2060, which will be a new experience for the country.
They add that technology spending during previous labor shortages increased dramatically. They expect tech spending to increase to 5.5% of GDP, which would be a new record high, up from 3.5% right now. The Alkeon team adds that this spending is in addition to the next wave of technological innovation, creating a "potentially powerful dual engine of secular growth for technology stocks that can lift consensus expectations meaningfully over a multi-year period."
This article first appeared on ValueWalk Premium