Silicon Valley investment insights. Will tech sector be swept higher by economic growth?

18th December 2013

Economic growth in the U.S. can provide a favourable backdrop for the technology sector, which has traditionally been cyclical in nature and swept higher by the rising tide of greater economic confidence. Will it happen this time. Walter Price, manager of the RCM Technology Trust at Allianz Global Investors, gives his view below.

Labour department figures show that the US economy added a better-than-expected 204,000 jobs in November. The most recent GDP figures were relatively strong and show the US economy growing at an annual pace of 3.6% in the third quarter of the year. Normally, this would signal an upturn for the technology sector because companies would see this as an opportune time to upgrade their technology infrastructure. However, the move to cloud computing has seen technology spending increasingly treated as operational expenditure rather than capital expenditure, and that means the usual cycle of upgrades and replacements is not as clear-cut as it once was.

In turn, this means we have to look outside the traditional cyclical growth areas of the sector for growth. To find this growth, we typically focus on companies with the most innovative technologies but great opportunities may also come from companies in recovery, who have had a bad run, but have restructured and are once again showing signs of becoming competitive. Alcatel-Lucent, the telecoms equipment maker, is one such company. New chief executive Michel Combes sold the group’s non-core assets and shored up its balance sheet by issuing high yield bonds. Last month its shares rose significantly.

There has been a huge surge in demand from wireless carriers scrambling to upgrade their networks to 4G technologies, a development which also stands to benefit Alcatel-Lucent. There have been rumours that Nokia OYJ might be interested in Alcatel’s wireless assets – via either a link-up or a buy-out. This would benefit Alcatel, which needs to raise cash, and Nokia, which has been historically weak in the US market.

An inevitable result of an improving economic environment is greater consolidation across the industry. Although this can be extremely supportive of share prices, it is not always a recipe for success. We are striving to focus on more profitable areas of consolidation, for example suppliers in component areas, such as memory and disk drives. Micron Technology – which makes up roughly 2% of the fund at present – is a good illustration of this is because its technologies are less vulnerable to obsolescence in the same way that some of the other hardware manufacturers may be.

Though we think more solid economic conditions are supportive for the overall sector, we believe that, over the market cycle, the strongest returns can be achieved by identifying new sub sectors within technology and investing in the emerging leaders. Very often in new segments of technology, the leader of that innovation tends to be found in the mid-cap sector. These companies have worked out the market and are beginning to dominate it. That said, not all large-caps are ex-growth. Those who dominate the ecommerce sector are a good example of this; ecommerce is still less than 10% of all commerce around the globe. We used to think it could reach 15-20%, but it now looks likely to reach 40-50%. Amazon, for example, is among the top ten holdings of the fund; it is a big company that still appears to have all the characteristics of a high growth company.

Walter Price has over 40 years of experience of investing in technology companies. He is based in San Francisco, giving him close proximity to many of the world’s most innovative companies. The RCM Global Technology Team manages US$3 billion in assets.

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